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Financial Liquidity Injection: Better Late Than Never at Trader’s Narrative

Last Friday when I found myself agreeing with Jim Cramer, I felt very uncomfortable for obvious reasons. But it seems that the central banks around the world, including the Federal Reserve are now on the same page.

It is all over the news that today and yesterday that the European central bank injected billions of euros into the banking system. The same was done on this side of the Atlantic with both the Fed and the Canadian central bank. Here’s the statement:

OTTAWA – In light of current market conditions, the Bank of Canada would like to assure financial market participants and the public that it will provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets.

These activities are part of the Bank’s normal operational duties relating to the stability and efficient function of Canada’s financial system. The Bank is closely monitoring developments, and will deal with issues as they arise.

The same went for Australia, Japan, Korea and other major markets. But the reason why international markets had to move was that the Fed was slow off the mark (just as Cramer schreeched).

Paging Helicopter Ben

Had the Fed acted last week, things would have been much more contained. Again, I’m not calling for an interest rate reduction. That would be a blunt instrument for this type of situation. And in fact it could trigger a panic if it is interpreted the wrong way (like Bear Stearns’ statement). But increasing liquidity, as the central banks around the world have done, is the right way to go.

It is lamentable that they didn’t take action earlier. This isn’t about rescuing fat investment banks or hedge funds, it is about ensuring the stability of the financial system. When banks are timid to borrow from each other, when trust starts to evaporate, that’s when things can fray at the edges.

By not acting fast enough, what happened was that the overnight lending rate actually shot higher than the benchmark rate. This kind of move is so extreme because you have to understand that the short term rates were significantly below the benchmark rates set by the Fed. So in essence we had a pseudo tightening of the Fed funds rate. Definitely the opposite of what the market has needed for a while and most definitely not what it needs in this stressful times.

Contrarian Comedic Insights
On the plus side, usually when things trickle down to the general media and the public, the move is almost unwound. Take for example these two videos from Comedy Central. In the first Cramer tries to explain his on camera meltdown:

In this one, the sub-prime market is explained in rather, shall we say, simple terms… to comedic effect:


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3 Responses to “Financial Liquidity Injection: Better Late Than Never”  

  1. 1 Prospectus

    So what exactly does it mean that they “added liquidity”, and how does it actually affect the markets? Everyone talks about it, but nobody really says what’s happening when they “add” it. I even called a talk radio show about the markets and they gave me some wandering answer about subprime and banks that didn’t answer the question. I think that they didn’t even know!

    Anyway, does the Fed actually buy stocks and pump up the market? Do institutions borrow money from the Fed and buy stocks? Do institutions, who are hit with redemptions and don’t want to sell their subprime portfolio into a no-bid situation, borrow from the Fed and pay off their investors? What is actually happening?

  2. 2 Phileo

    Hi Prospectus,

    The Fed is providing low interest loans (ie. below the Fed. Fund rate) to the banks themselves.
    My link explains the gory details here

  3. 3 Babak

    Prospectus, here’s the the best detailed explanation I found. This is Fed101 stuff but to most their operation and structure is a mystery so it is no wonder there is so much confusion.

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