The Augean stables were so full of muck that no ordinary mortal could clean them. Hercules was able to perform this labour in a single day by diverting two rivers. Governments dealing with the mess in the financial system are faced with a similarly Herculean challenge.
The authorities certainly had an incredibly busy weekend. No fewer than six of them were involved in rescuing leading financial institutions. But as yet, the diversion of taxpayer funds has not done the job.
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Here’s a preliminary count: the US is set to provide $700 billion (Rs32.8 trillion) to buy troubled assets from banks; the Netherlands, Belgium and Luxembourg pulled together €11 billion (Rs74,580 crore) of equity to keep Fortis NV in business; Germany helped arrange a €35 billion funding line for Hypo Real Estate Holding AG; and the UK has nationalized Bradford and Bingley Plc. with its £52 billion (Rs4.5 trillion) balance sheet.
And on Monday, Iceland joined the list. It paid €600 million for 75% of the shares of Glitnir, the overleveraged island’s third largest financial group.
It’s an awesome list. True, the numbers aren’t exactly comparable and the governments say they will get most of the money back, whenever normalcy returns to the markets. But that is still a pretty distant prospect. The gap between three-month interbank euro lending rates and expected government rates was at an all-time record 100 basis points on Monday morning. One basis point is one-hundredth of a percentage point.
Banks don’t trust each other, equity investors don’t trust banks that look weak and cash-holders would rather buy government paper than take their chances with commercial paper or even bank deposits. The mistrust is self-fulfilling, as banks without funding fall into spirals of terminal decline. It is also justified. Mounting losses from troubled US mortgages have a destructive wake.
The general mistrust has left only governments able to raise and disburse money. The rescues show the governments are trying. Central banks, which increasingly look like government agencies, are also doing what they can.
On Monday, the European Central Bank (ECB) offered a “special term refinancing operation”. There’s no pre-set limit to the funds available and the 7 November maturity will be renewed “at least until beyond the end of the year”.
Effectively, ECB is giving banks as much cash as they want for as long as necessary.
The financial troubles long ago outstripped the markets’ self-healing capacity. Now they keep running ahead of the governments’ efforts. Even before being passed into law, the US plan has widely been condemned as inadequate, because it doesn’t give banks what they need most—capital.
And that’s the catch. The financial world is set to remain in capital-destruction mode as long as deleveraging continues to bring down asset prices—creating losses for lenders. Governments looked on during the decade of financial binging. Now they are left with a gigantic mess to clear up. They have only done part of the job.