Duncan’s Economic Blog

Liquidity & the Crisis

Posted in Uncategorized by duncanseconomicblog on August 5, 2011

Gilliam Tett today in the FT makes for alarming reading pointing out the worrying parallel between what is unfolding inEurope and what happened in theUS in 2008.

One point in particular strikes me as being crucial – the continued reliance of banks of short term funding. Which leaves them exposed to rapid moves in short term market rates – a la 2007/08 and now 2011.

I’m not denying that many Eurozone banks face a solvency crisis but in the coming days a liquidity crisis could have a wide spread impact on all banks in Eurozone – and indeed beyond, the poor results from Lloyds & RBS leave them looking exposed.

The news that BNY Mellon (a large US bank) is now charging to hold large deposits (actual nominal negative interest rates) is especially alarming. It suggests to me that the reports of US banks and money market funds pulling cash fromEurope and holding in theUS are true.

Some US banks risk being flooded with cash whilst Eurozone ones are starved.

Watching the inter-bank lending rates in the next few days will be crucial.

This really does remind us of the importance of liquidity regimes – something George Osborne reportedly wants to scale back in the UK.

All of which reminds us of the importance of liquidity preference.