Thursday, November 27, 2008

Banks Hoarding Cash

With all the market unrest, and the year end reporting coming up soon, it appears that banks have resumed hoarding cash to make their balance sheet look better to investors.
The cost of borrowing in dollars for one month in London jumped the most since 1999 as banks sought to bolster balance sheets through year-end amid a squeeze on credit that’s being exacerbated by the global economic slump.

The London interbank offered rate, or Libor, that banks say they charge one another for such loans climbed 47 basis points to 1.90 percent today, British Bankers’ Association data showed. The Libor for three-month loans rose two basis points to 2.20 percent. The Libor-OIS spread, a measure of the willingness of banks to lend, increased.

“There is some concern about the turn of the year,” said Patrick Jacq, a senior fixed-income strategist in Paris at BNP Paribas SA. “I wouldn’t be surprised to see this tension easing over the next few days as central banks address the situation with more liquidity.”

With little more than a month to go until the end of 2008, banks are vying for loans that mature after Dec. 31 to strengthen their balance sheets as they prepare to report to investors. Financial institutions mark the value of loans and cash positions at the end of each quarter. The euro interbank offered rate, or Euribor, for one-month loans rose 22 basis points to 3.61 percent today, the first increase in 24 days, according to the European Banking Federation.

“This is purely because the loans are crossing year-end,” said Barry Moran, a money-markets trader at the Bank of Ireland in Dublin. “It’s a little bit harder to tell this year how high rates might go because central banks are going a long way toward providing excess liquidity."
Look for the Feds to lower the discount rate another 0.25% and pump even more money into the banking system in December.

Now, that leaves the issue of what happens to all this cash in the banking system after the reporting period is over?

Well, eventually the banks are going to get tired of sitting on all this cash and will want to use it. That means loans and lots of them (hopefully, this time around, they actually vet the applicants). And that means the market and the economy will take off.

At first it will see like a miracle. But then when unused production capacity is absorbed, we will see high inflation.

Also, get ready for phase 2 of the credit defaults as credit card and other consumer debt defaults start hitting hard in January. They are much smaller though, per person than mortgages and so the down side should be a little easier to handle in the market. If you did not notice, American Express got itself declared a bank the other day so it can borrow at the discount window and get a piece of the bail out. They see the credit card defaults coming.

At this point the bigger economic threat is not the recession (as long as Obama does not raise taxes any time soon), but the ensuing inflation we will see.

But regardless, we will have to pay higher taxes sometime down the road. With the $8.5 trillion bail out, we not only have borrowed on our future, we have passed that burden onto our children and grandchildren.

We have been following a path of pain avoidance. Eventually, we have to pay the tab.

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