Financing Crunch Persists As Investors Remain Wary
A wave of government actions boosted the U.S. stock market on Thursday, but it did little to alleviate a deepening problem: Lending markets are starved for cash.
In an extraordinary coordinated effort, the Federal Reserve, the European Central Bank and other major central banks made hundreds of billions of dollars in added loans available to commercial banks around the world. But those banks balked at lending the money to each other or to clients and investors in need of it. Instead, they hoarded the cash amid uncertainty about how badly this week's financial turmoil will affect them and their trading partners.
To make matters worse, another important source of money for banks and companies began to dry up, as jittery investors yanked cash out of money-market funds. The funds pump money into credit markets by buying short-term IOUs issued by banks and companies, called 'commercial paper.' A hefty $78.7 billion was withdrawn from the largest money-market funds on Wednesday, according to Crane Data LLC.
Putnam Prime Money Market Fund said it had closed Wednesday and would distribute assets to customers because of 'marketwide liquidity issues.' The $12.3 billion fund, available only to big clients with a $10 million minimum investment, said it held no debt from such issuers as Lehman Brothers Holdings Inc., Washington Mutual Inc. or American International Group Inc.
The wave of withdrawals from these money-market funds, which are supposed to be as safe as bank accounts, began earlier this week. It was sparked by an announcement that the Reserve Primary Fund had 'broken the buck' -- that is, its net asset value had fallen below $1 per share. The fund held debt from Lehman Brothers, which filed for bankruptcy-court protection earlier this week.
Bank of New York Mellon Corp.'s $22 billion BNY Institutional Cash Reserve Fund, which isn't registered as a money fund, said its net asset value slipped to $0.99 on Tuesday, although it says it has isolated Lehman assets that helped drag it down. Meanwhile, shares in respected money-management firms such as State Street Corp. and Genworth Financial Inc. plunged as investors pulled cash from the funds.
'I think this is probably the worst I've seen,' says Robert Bishop, a portfolio manager at SCM Advisors in San Francisco, referring to the exodus from money-market funds.
Thursday's developments highlight a problem that has dogged central bankers since the beginning of the credit crunch: Cash isn't getting where it needs to go to keep markets running smoothly and fuel the broader economy.
In a note to clients, Morgan Stanley interest-rate strategist Laurence Mutkin said that Thursday's concerted central-bank move 'has made little if any impact on the illiquidity gripping financing markets.'
In normal times, banks make about $1 trillion in overnight loans to one another every day -- money they use to cover gaps in timing between payments they must make and cash coming in. But that flow has diminished to a trickle. The $180 billion pumped into the system on Thursday still leaves a big gap.
Short-term interest rates remain elevated as banks and all kinds of investors refuse to lend or charge high rates. As central banks pumped money into the market, the London interbank offered rate, or Libor, a benchmark that is supposed to reflect the short-term rates at which banks make overnight dollar loans to one another, dropped to 3.843%, from 5.031% on Wednesday. But the three-month dollar Libor rate climbed to 3.203%, from 3.062%. Both rates remain well above their levels from last week. On Sept. 11, the overnight rate was 2.138% and the three-month rate was 2.818%.
The exodus out of money-market funds is taking a big chunk out of the 'commercial paper' market, a vital source of financing for companies. Total commercial paper outstanding in the U.S. fell by $52 billion to $1.7 trillion in the week ending Sept. 17, the sharpest weekly decrease this year.
If investors balk at buying commercial paper, then banks will have to find money elsewhere to pay debts maturing in coming months. A dozen of Europe's biggest banks must pay off some $200 billion in short-term debt over the next 12 months. Much of that debt carries a maturity of only 60 days, meaning most of the burden will come soon, according to a person familiar with the euro commercial-paper market.
Also, specialized funds such as structured-investment vehicles, set up by banks to obtain funding, have gone out of business.
Banks are turning to central banks as their main source of cash. 'Central banks' liquidity injections have been mostly absorbed by the banks themselves to replace lost funding sources,' says Scott Peng, an analyst at Citigroup Inc.
Banks are also facing cash demands in other areas. Complex bets on derivatives are creating big liabilities. Problems increased in recent days as the Lehman bankruptcy filing and the crisis at American International Group Inc. caused the cost of insuring against defaults on corporate debt to rise sharply. When the cost rises, sellers of such insurance, including banks and big insurers such as AIG, must put up extra cash as collateral to guarantee they'll be able to make good on their obligations.
As of Thursday, the cost of default insurance on $10 million in U.S. corporate debt stood at $175,000 annually, up from $146,000 last week, according to the Markit CDX index. In recent days, the cost of insurance has spiked as high as $200,000. That sizable move over a short period of time likely triggered billions of dollars worth of cash calls between dealers and other firms.
Carrick Mollenkamp / Neil Shah / Diya Gullapalli
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