The Sub Prime Crisis: Trouble in the inter bank market

(Ref: The Economist, dt. 18 August)

The inter bank market is supposed to be one of the safest places in the financial system. After all, the borrowers are people with some of the best credit ratings gong around. But the sub prime crisis has challenged this assumption. On August 9th/10th, US rates hit 6%, 75 basis points over the Fed benchmark and in the Euro area, 4.7%, 70 basis points over the benchmark of 4%. Under normal market conditions, these spreads would have been much smaller. To ease the situation, the ECB provided funds to the tune of $131 billion on August 9th followed by about $85 billion on the following day. The Fed injected liquidity to the tune of $24 billion and $38 billion or the two days respectively. The Fed also allowed mortgage backed securities, though guaranteed by federal agencies, as collateral. The liquidity injection did succeed in pushing money market rates down. But it is not clear whether these moves have really dealt with the core of the problem – the absence of trust in the markets today. As the Economist summed up, “Markets are jumping at every shadow. Only when imagined bad news has been flushed out will inter bank markets return to obscurity.”