Interest Rate Cuts vs. Recapitalization

Global rate cuts: attacking the symptom?

After yesterday’s move by the Fed into the commercial paper market, today’s big news is a global interest rate cut, including the Fed, the European Central Bank, and the Bank of England, among others. The effect of an interest rate cut should be to reduce borrowing costs across the board, which is a good thing for the real economy. However, the rate cut may not have a direct impact on the crisis at the heart of the financial system, which is that banks are not lending to each other. To put this in perspective, the spread between 3-month inter-bank lending rates and 3-month Treasury bill rates – a measure of how willing banks are to lend money to each other, as opposed to socking it away in risk-free Treasury bills – is running at about 4 percentage points. Ordinarily, it should be about 0.5 percentage points. As a matter of simple arithmetic, a 0.5 percentage point cut in central bank interest rates is small compared to a 3.5 percentage point increase in risk premia. As long as lenders are afraid their borrowers could go bankrupt, lowering the cost the lenders pay for money will only slightly lower the price that they charge for money.

Still, though, today’s move is a valuable signal that the world’s central bankers are on the same page and that they will do whatever they can to fight the crisis. And the good news may have come from the United Kingdom, where the government announced a straight-up bank recapitalization plan, in which 25 billion pounds will be used to buy preferred shares in eight banks, and another 25 billion pounds will be allocated to buy shares in those or other banks. Banks that have more capital are less likely to go bankrupt, making other players more willing to lend to them. As we’ve pointed out before, the Paulson Plan may have the indirect effect of increasing bank capital (because we expect Treasury to overpay for the securities it buys under the plan), but uncertainty over how that will work has diluted its impact on the markets. Explicit bank recapitalization is a more direct way to attack the problem.

One response to “Interest Rate Cuts vs. Recapitalization

  1. simon;
    this may seem more than pretty simple minded to as distinguished an economist as yourself; yet, as the american portion of the 6-billion member general public [i expect the previous baselines were set up on a 2.5 to 3 billion world general public… and the american public being the focal point of world wide population decline of “space”] has their resources [mostly supply but, some demand] counted into our modern economic plan without much thought being given to their ability to supply the demand side with jobs, healthcare, top-to-bottom standardization of middle-class life strivings i seriously doubt if any mamby-pamby bank transfers will do anything but, give the bankers something to do.
    it’s been quite obvious that free-market economics [unbridled and without or with less, year by year, constraints] was going to lead to a complete failure in any creed of govt, culture or society which exists for the free- markets [unbridled and without any restraint … only serving it’s own interest, always through profit… right and knowing best] will simply feed off the govts, cultures and societies it encounters and like a spoilt child glutting on tasty poison get sick and/or dies …
    quite obvious for at least 30 years what is happening and, you’re quite right addressing symptoms [unless it involves taking, like with medicine, less poison to build up immunity] will not get the job done. it has been quite obvious [for many years] to the ole’ hillbilly that i am … this extreme greed has and could only lead to a re-structuring of our society in social [or trickle-up] terms; why else would our democratic [constitutionally regulated] republic embrace this kind-a spoilt child, immaturity as the economic system for the most progressive and free culture which has ever existed on the earth… because we are in the process [as is mandated by the first paragraph of our constitution] of a one decade maturation which got out of hand [think about it… maybe think about it in terms of “escape from freedom” fromm’s book used from the point of power rather than freedom…maybe from the apriori of assumptions without your baseline].
    i applaud your intense and erudite efforts to save our culture [really we have no culture other than our constitution]; yet, it may be too far out of hand to save “it” as “it” is. perhaps we need to think in terms of the consequences a spoilt, negatively enforced child might have on not only his own {age related only] adulthood as well as everyone he or she encounter the earth and call this child free-market [supply side only] economics … at some point this child will feel the need to grow up – perhaps this is the point we reached 10 years ago and rather than allow the child to grow up we simply gave the child “more” rather than deal with the tantrums – the most obvious solution is socialism but [and yes, i’ve worked in socialist countries and found them even more screwed-up then our’s seems to be or be-becoming now], only partially so and only for a finite amount of time [meaning constitutionally mandated re-evaluation might be necessary] … perhaps if we instituted a vast national service policy [all children 17 to 19 or 21] must participate and the military could be volunteered out of it as well as could small and large companies tap the pool for help which doesn’t need health insurance because health insurance would be included as well as the middle class basics of what ‘ust to be called life-style but is fastly becoming survival; then some could be either stay on permanently, man the military’s continuity, greening-up, go on to college or {even in retirement} resume their service later [again, or as has become a popular response in today’s confusing economy] or … “whatever;” lots of possibilities for this baseline.
    i’m a private person [who did pay his dues… so to speak] and mandating anything goes against my personal nature; yet, this partial-socialism seems to be becoming an option and doing so, more-so in a way which seems to have been historically planned for the simple minded choice of it’s this or else [monarchy/or the oligarchy of free market cornered and controlled by those who are above the fray, world-war or who knows the whimper of a planet which has used itself up]. the main thing i see as positive about partial socialism [as opposed to free-market oligarchy or the opposite – some kind-a strict state-controlled life] is the option it gives to the actual entities born under the domain of the us constitution, the “we the people” [not excluding the new corporate, unconstitutional, entities – being trickled-up to]… the option to become mature enough to [again] become adult citizens.
    i consider this not a solution or is it meant to be or become one… this is just one of [hopefully just] hundreds of consequential options which must be, so to speak, vetted … a duty which our general [private leaning] free-market economics seems to either have or attempted by nature … eliminated.

    an ole’ hillbilly trying to learn to type
    dave