Thursday, December 13, 2007

Central Banks

Unclogging the system

A collaboration over the credit crisis

CENTRAL bankers are supposed to be boring and predictable. But on Wednesday December 12th the rich world’s monetary authorities stunned financial markets with a dramatic, joint plan to ease the liquidity squeeze in global money markets. America’s Federal Reserve, the Bank of England, the European Central Bank (ECB), the Bank of Canada and the Swiss National Bank all pitched in. The central banks of Sweden and Japan said they, too, were watching developments and would act as necessary. All told, it was an impressive show of central-bank co-ordination.

Financial markets have been seizing up for weeks. The spreads between the federal funds rate and the prices charged by banks to borrow from each other have widened dramatically since early November. By some measures, the financial system is more blocked than it was in September. And it has long been clear that central banks’ attempts to sort out the mess are failing. The Fed’s discount window, for instance, through which it lends direct to banks, has barely been approached, despite the soaring spreads in the interbank market. The quarter-point cuts in its federal funds rate and discount rate on December 11th were followed by a steep sell-off in the stockmarket, only partly reversed the next day.

The central banks have pinched each others’ best ideas for how best to ensure that liquidity gets where it is needed. And they have also, in effect, acknowledged the international nature of the liquidity squeeze, by promising to provide reciprocal currency-swap lines.

The Fed made the most dramatic changes. It introduced a “term-auction facility” through which all banks eligible to borrow from the discount window could bid for one-month money. The first two auctions are to be held on December 17th and 20th, with $20 billion to be sold at each. Two more are to follow in January. The Fed also announced temporary swap lines with the ECB and the Swiss National Bank, worth $24 billion, allowing those central banks to lend dollars to banks pledging euros or other currencies.

The Bank of England promised to inject more money into the markets, increasing its two forthcoming term auctions, on December 18th and January 15th, from £2.85 billion ($5.8 billion) to £11.35 billion each time. In all, £20 billion will be supplied at three-month maturities, where strains have once again become particularly acute. And unlike its previous emergency auctions, in late September and October, the price of these funds will be determined by market demand at the auction, not set at the penalty rate that deterred any bank from bidding for the money.

The hope is that by extending the maturity of central-bank money, broadening the range of collateral against which banks can borrow and shifting from direct lending to an auction, the central bankers will bring down spreads in the one- and three-month money markets. There will be no net addition of liquidity. What the central bankers add at longer-term maturities, they will take out in the overnight market.

In some ways, the announcement is a triumph for the ECB. Both the Fed and the Bank of England have shifted away from the familiar tools of a lender of last resort—providing funds freely to institutions at a penalty rate. They have moved closer to the ECB’s approach of auctioning funds to a broader set of actors against a wider range of collateral—in effect becoming a market of last resort. The shift makes sense: in both Britain and America it was increasingly clear that the stigma associated with approaching the central bank directly was deterring deserving borrowers. Walter Bagehot’s dictum needed updating when the crisis of confidence affected entire markets rather than single banks.

But there are risks. The first is that, for all the fanfare, the central banks’ plan will make little difference. After all, it does nothing to remove the fundamental reason why investors are worried about lending to banks. This is the uncertainty about potential losses from subprime mortgages and the products based on them, and—given that uncertainty—the banks’ own desire to hoard capital against the chance that they will have to strengthen their balance sheets. Nor is the shift from direct lending to auction sure to work: for all the praise heaped upon the ECB, the spread between the ECB’s repo rate and euro-denominated interbank rates is no less worrying than that in America or Britain.

Furthermore, central banks will now be more intricately involved in the unwinding of the credit mess. Since eligible banks have similar access to the liquidity auction, the central banks are implicitly subsidising weaker banks relative to stronger ones. By broadening the range of acceptable collateral, the central banks are taking more risks onto their balance sheets.

Set against the dangers of all-out financial seizure, these risks seem worth taking. More important, if they succeed even in modestly loosening the money markets, they will reduce the pressure on central banks to use the broader tool of lower interest rates. Across the developed world monetary policy is becoming increasingly hard to steer. Growth is slowing, because of the fall-out from the financial turmoil and the weakening American economy. In its recent Economic Outlook the OECD revised down expectations for 2008 growth in virtually every country. Yet strong demand growth in emerging economies is stoking commodity-price inflation. In America consumer-price figures due on December 14th may well show that, thanks to soaring fuel costs, overall consumer prices rose 4% in the year to November. Even if financial markets were functioning normally, central bankers would face hard choices. With the system gummed up, that calculus is harder still.

Britain and Europe

Blame the secretary

Britain's Gordon Brown fumbles over the new European treaty

IT DID not take long for the “Macavity” jibes to start, once word spread that an unconvincing diary clash would prevent Gordon Brown, Britain's prime minister, from attending a ceremony in Lisbon to sign the European Union’s controversial reform treaty. When it subsequently emerged that Mr Brown would fly to Lisbon on Thursday December 13th anyway, to sign the treaty discreetly after the main ceremony had finished, the jokes gave way to head-shaking disbelief in several capitals.

Westminster insiders long ago began to notice that Mr Brown has a talent for not being there when trouble hits. Lord Turnbull, once Britain’s top civil servant, merely put a name to it when he compared him last March to T.S. Eliot’s fictional cat. Now Europeans are learning about this trait for themselves.

The treaty is deeply unpopular in Britain. It is disliked both by those who fear that it undercuts their country’s freedom of action in important respects and by those who resent being denied a referendum on it, even though one was promised by Tony Blair, Mr Brown’s predecessor, on the constitution that the treaty largely re-packages.

So while EU leaders prepared for a familiar ritual on December 13th (solemn signatures in some ancient palace—or, in this case, a monastery—followed by champagne toasts and speeches about European unity), Mr Brown announced that he could not miss a scheduled grilling by committee chairmen in the House of Commons. Only after that could he fly to Lisbon to catch the end of an EU leaders’ lunch. At some point, during coffee perhaps, he would pop off and sign the treaty.

Alas for Mr Brown, this grudging half-visit seems the worst of all worlds. Eurosceptics in Britain are enraged that Mr Brown is signing the treaty at all. In Brussels the prime minister’s antics inspired embarrassment and puzzlement—not least when his aides insisted that the timing of the Lisbon ceremony was known too late to alter Mr Brown’s diary. Pained European officials noted that Mr Brown was personally informed of the date, time and place of the ceremony in October by the prime minister of Portugal, which holds the current rotating presidency of the EU.

Strictly speaking, diplomatic protocol did not require Mr Brown to be there—his foreign secretary, David Miliband, was already due in Lisbon for the ceremony, and ministers have signed treaties before. The Single European Act, for example—a more significant text—was signed by Lynda Chalker, then a junior minister. But the Portuguese had hoped that if national leaders signed the treaty in person, the symbolism of the event would draw a line under the crisis provoked in 2005, when French and Dutch voters rejected the original constitution.

Mr Brown’s snub will be forgiven—in the end, Brussels folk see it as an internal problem, intelligible only to the British. But the dithering beforehand (unnamed British “sources” had hinted that he might not go to Lisbon at all) was more problematic, as was the lameness of his excuse. In diplomacy, indecision can be as harmful as the final decision taken.

BOC Aviation Aims to Buy More Planes From Airlines Next Year

Dec. 14 -- BOC Aviation, Bank of China Ltd.'s aircraft-leasing unit, aims to boost earnings by buying planes that airlines have ordered and are unable to finance because of the global credit crunch.

Asia's biggest lessor plans to buy as much as $2 billion worth of planes from airlines next year, more than double the $700 million it purchased in 2007, said Chief Executive Officer Robert Martin. The Singapore-based company received a $1 billion credit facility, its largest loan, from Bank of China this month at a rate lower than what it would get from other banks, he said.

``With issues that are hitting financiers in Europe and US related to subprime, we are now seeing a slowing down of liquidity growth in Asia as well,'' Martin said in an interview yesterday. ``With a financing market that is going to be tighter, this is the right time for us to go back to the sale and leaseback market.''

The worldwide credit squeeze, caused by losses in securities linked to subprime mortgages, is pushing borrowing costs higher. Airlines, faced with record fuel prices and a possible slowdown in the U.S., may find it harder to pay for new planes, making sale-and-leaseback arrangements more attractive.

``Sale and leasebacks are pretty good because you get your money back from the lease and a profit depending on the residual value that comes off the lease,'' said Jim Eckes, managing director of Indoswiss Aviation. ``It benefits the airline because they don't have to borrow expensively from the bank.''

Borrowing Costs

Borrowing costs jumped in mid-August as banks, including Bear Stearns Cos. and Merrill Lynch & Co., started reporting losses on securities tied to U.S. subprime mortgages. The global credit slump may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a ``substantial recession'' in the U.S., Goldman Sachs Group Inc. forecast on Nov. 16.

The three-month dollar London interbank offered rate, or Libor, climbed as high as 5.15 percent last week from 4.87 percent a month before. The rate dropped to 4.99 percent yesterday. The rate was 5.725 percent on Sept. 7, the highest since January 16, 2001.

The Bank of China loan will be at an interest margin lower than the rate the lessor have been getting from other banks, which have charged 45 to 55 basis points above Libor. Libor is a benchmark for borrowing costs. A basis point is 0.01 percentage point.

``That positioned us very well to be able to assist our airline customers in financing their aircraft,'' according to Martin, who was the aircraft finance director at the investment banking arm of HSBC Holdings Plc in Hong Kong prior to joining the leasing company in 1998. ``What the debt line gives me is the flexibility to go in very quickly.''

Tiger Air, Easyjet

Airlines such as Tiger Airways Pte, a budget carrier part- owned by Singapore Airlines Ltd., and Easyjet Plc, Europe's second-biggest discount airline, have funded aircraft acquisitions by selling the planes and then leasing them back. Jet Airways (India) Ltd. said it made a profit from the sale and leaseback of four Boeing Co. 737 aircraft in September.

About half of BOC Aviation's business comes from sale and leaseback agreements, with the remainder from direct leases. Next year, it aims to spend 80 percent of its marketing efforts on getting new sale-and-leaseback agreements, Martin said, backed by the credit line from the Bank of China and $500 million of unused bank loans. The unit is not publicly traded.

Fuel Costs

Rising fuel costs are curbing profitability at airlines, limiting potential funding for new aircraft. Airline earnings will fall 11 percent next year because of higher oil prices and an expected slump in demand in the U.S., the International Air Transport Association said this week.

At the same time, higher demand for air travel in Asia has boosted orders and prices at Airbus SAS and Boeing Co. The world's two biggest aircraft makers said in November orders will peak this year, beating a record set in 2005.

BOC Aviation, which has posted profits every year since it started in 1993, is set to report record earnings for the year ending Dec. 31, Martin said, declining to elaborate.

The company had a record profit of $70.5 million for the year ended March, doubling from the year before. It has changed its fiscal year end to December, in line with its parent.

Demand for aircraft is so high that 75 percent of BOC Aviation's 60 planes on order with Airbus and Boeing have been leased, with the next available delivery slot in the middle of 2011, Martin said.

The lessor, which wants to build a portfolio comprising single-aisle and medium-sized planes, is waiting for the ``right price'' before buying more, Martin said. It has 40 Boeing 737s and 20 Airbus A320s on order.

``Business does look very good, because there aren't enough aircraft at the moment,'' said Peter Harbison, managing director of the Centre for Asia-Pacific Aviation. ``Lease rates have virtually quadrupled over the last few years.''

Japan's Business Sentiment Slumps More Than Forecast (Update2)

Dec. 14 (-- Confidence among Japan's largest manufacturers slumped more than economists forecast, as a stronger yen eroded exporters' profits and the rising cost of credit clouded the outlook for global growth.

The Bank of Japan's quarterly Tankan index of manufacturer sentiment fell for the first time since March to 19 points in December from 23 in September, the central bank said today in Tokyo. A positive number means optimists outnumber pessimists.

Japan's biggest manufacturers such as Canon Inc. are more dependent on markets abroad just as a slowing U.S. economy dims prospects for global growth. Small companies, which employ 70 percent of Japan's workers, predicted business conditions will deteriorate over the next three months, making it more difficult for the Bank of Japan to justify raising interest rates.

``Japanese corporations are more concerned about the U.S. situation than before,'' said Martin Schulz, a senior economist at Fujitsu Research Institute in Tokyo. ``The Bank of Japan is now basically completely boxed in.''

The yen traded at 112.39 per dollar at 9:11 a.m. in Tokyo from 112.33 before the report was published. The median estimate of 45 economists was for the large manufacturers' index to drop to 21 points.

Bank of Japan Governor Toshihiko Fukui said last week he's concerned falling profits at small companies could hamper wage growth and stymie consumer spending.

Fukui says Japan's interest rates, the lowest among industrial nations, need to rise to prevent inefficient investment that may cause problems for the economy later on.

Worsening Conditions

Large manufacturers see business conditions worsening. An index measuring expectations for confidence next March sank to 15, which, if realized, would be the lowest in three years.

Optimists among small manufacturers barely outnumbered pessimists, with the index rising to 2 from 1. They see confidence deteriorating to minus 3 in March.

Japan's economy grew more slowly than the government initially estimated in the three months ended Sept. 30. Profit growth at large companies slowed to 1.3 percent in the third quarter from 14 percent in the second, as a 10 percent gain in the yen over the past six months cut margins. At small and midsized companies earnings sank 4 percent.

``The subprime problem, high energy prices, high food prices -- all of these things are creating an environment that's more difficult for Japan,'' said Robert Feldman, head of economic research at Morgan Stanley in Tokyo. The gap between sentiment at large and small businesses is ``a sign of trouble for the economy.''

Canon's Sales

Canon, which gets three quarters of sales outside Japan, reported its first profit drop in two years last quarter and cut its annual sales estimate because it had assumed the yen would trade around 115 against the dollar. The currency has averaged 113.12 per dollar so far this quarter.

Large manufacturers said they expect the yen to trade at an average 116.07 against the dollar in the year ending March, compared with the 115.2 they estimated three months ago. It's still weaker than the 106.6 level at which most exporters say they can stay profitable.

Companies must also contend with soaring materials costs. Crude oil prices rose above $99 a barrel for the first time in November and wholesale costs for businesses have risen every month since March 2004.

As costs rise, slack demand from consumers is forcing companies to sell their wares more cheaply, keeping the economy from shaking off a decade-long bout of deflation.

Price Cuts

Aeon Co., which sells everything from bicycles to steaks, last month cut the price of yogurt and soy sauce by as much as 25 percent. The move was intended to attract shoppers, whom Bank of Japan policy maker Seiji Nakamura describes as ``resistant'' to price increases.

The government this week announced a plan to spend as much as 60 billion yen to support small businesses and households hurt by higher oil prices. It also said large companies should avoid forcing subcontractors to absorb rising costs.

``What's changed in the last three months? Sentiment has deteriorated,'' said Junko Nishioka, a senior economist at ABN Amro Securities in Tokyo. ``People are thinking: from here things get worse.''

Even after today's result, the large manufacturer index is still near a 13-year high of 26 reached in September 2004. The survey plunged to minus 51 in 1998 during the Asian currency crisis, the lowest since 1975.

The Tankan, which means short-term economic outlook in Japanese, asked 10,671 companies for their views on sales, profit, spending, hiring and confidence. It surveyed companies from Nov. 12 to Dec. 13.