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Banking

Bond Outlook March 12th

This crisis is not just about illiquidity but also about insolvency and the fear that borrowers, including banks themselves, will not repay. The Fed “boost” misses the point.

Bond Outlook [by bridport & cie, March 12th 2008]

The USD 200 billion+ “boost” by the Fed is very clever (maybe too clever by half), as it addresses the illiquidity problem of mortgage-backed securities by allowing the use of AAA bonds as collateral for Treasuries. This gives the banks the means to borrow from each other and meet the needs of their clients. Equity investors clearly “bought” this line on Tuesday, although there is something inevitable about any move by the Fed to “inject money” causing a short-term stock-market rebound, exaggerated more than ever this time by unwinding of short positions.

The Fed is addressing the liquidity problem, but is the credit crisis only about liquidity? We (and many others) fear not. Solvency is also very much at stake, i.e. the balance sheets of many financial entities are vulnerable because of the write-down of assets. On the one hand banks cannot lend because they do not have the cash or the capital adequacy (and the Fed is addressing this issue), but on the other they are reluctant to lend to anyone if the risk of bankruptcy is in the air.

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