News reports yesterday suggested that the liquidity crisis had dissipated. We had seen the worst and that liquidity from central banks was not needed as much as required last week. While every central bank has commented that liquidity is available, the net injection of money has declined from the major infusions of last week. The big problem with liquidity infusion during a crisis is that we do not know how long a crisis will last.
There has been much talk about when liquidity should be added, yet there has been less discussion about when liquidity should be reversed. These liquidity investments have a way of hanging around as extra money for longer than is often necessary. The fed funds future sis now expecting Fed ease by the end of September. How do you now signal that funds will be taken out of the system?and there are new private buyers, the Liquidity can be taken out of the system if the size of the credit problem has been fully revealed to the suppliers of funds. Nevertheless, problems are now popping up all over the place. For example, Sentinel money management is asking regulators if they could halt withdrawals. Sentinel provides cash management services. If there are no lenders or residual buyers of these debt instruments, central banks may be providing funds for some time. If there is a tightening of financial institution regulation or if standards for hedge funds are tightened, the need for alternative funds from central banks may actually grow.
The crisis is not over and the actions of central barks as a player in this financial drama are just beginning. The addiction to easy credit is hard to break.
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