The River of Liquidity is Frozen

When big banks that were considered solid last year now suddenly are going under then almost any financial institution get very afraid of lending each other money.

I remember getting my first banking job in the end of the last banking crisis in Norway. I was hired as a junior trader assistant on the USD fixed income derivatives desk. We were sitting next to the people funding part of the banks operations in the USD money market, the local NIBOR market was basically completely frozen and very few international banks wanted exposure to Norwegian banks. Banks that a few years before all had been AA or AAA rated had all been bailed out by the government in one way or the other.

Often people at our desk that were supposed to focus on USD: swaps, caps, floors, and swaptions had to spend some time helping the USD funding desk of the bank. The government had just re-capitalized the bank, but still the full trust had not returned, I can just imaging how bad it must had been in the middle of the crisis. Often I got handled over a long list with foreign bank names from the head of the funding desk. I then contacted all these banks over Reuters asking for overnight loans (O/N) in USD. Most banks told no interest, a few banks gave us overnight loans at high money market rates (due to the global credit crunch), often + an additional mark up. This part of the job I found less interesting at that time, now I figure out this was some of the best training I could get.

The same is going on now, but on a much larger scale globally. Many banks are now mainly funding their operations overnight, by rolling overnight loans or T/N: Tom Next (Tomorrow next loans). Hopefully the bail out package will help.

Unfortunately this is not like many European politicians have assumed, a US banking crisis with a few side effects spilling over to Europe. This is a global credit contraction. The European real estate is likely in the beginning of its fall. Now that liquidity is freezing up the real estate prices will accelerate to the down side. And also many over borrowed corporations in US and Europe will not survive. The collateral European banks helped spiraling into a gigantic bubble by issuing more and more credit have just started to bust. The equivalent of FDIC insurance is lower in many European countries than in US, it just went from 100k to 250k USD in USA. In other words major danger of big bank runs in Europe, we already had a few.

Well noting is for sure, but I think this is a likely scenario based on a few back of the envelope calculations. It will hopefully turn out much better than this, but it could also turn out much worse.

The River of Liquidity is frozen and we are probably heading for a very cold and very long winter, I am not even sure there will be a summer next year, but I strongly hope so. As a Norwegian I am am quite used to ice and snow, I was almost born on the ice so to say. In a financial melt down do not panic, cool down!