Siobhan Kennedy and Suzy Jagger
Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump $280 billion (£140 billion) into global markets was seen as a sure sign that at least one financial institution was struggling to survive.
The name on most people's lips was Bear Stearns. Although the Fed billed the co-ordinated rescue as a way of improving liquidity across financial markets, economists and analysts said that the decision appeared to be driven by an urgent need to stave off the collapse of an American bank.
“The only reason the Fed would do this is if they knew one or more of their primary dealers actually wasn't flush with cash and needed funds in a hurry,” Simon Maughan, an analyst with MF Global in London, said.
Mr Maughan said that the most likely victim was Bear Stearns, the first bank to run into trouble in the sub-prime crisis and the one that, among all wholesale and investment banks, is most reliant upon the use of mortgage securities for raising funds in the money markets.
“The average financial institution was up 7.5 per cent yesterday after the Fed's actions, but Bear Stearns rose just 1 per cent on massive trading volume,” Mr Maughan said. “The market is telling you it's Bear Stearns.”
The Fed's intervention sparked fears of deeper underlying trouble because it came only days after it had made $200 billion (£99 billion) available in emergency funds. The nature of the financing was also unusual, bankers say, because it was the first time that the Fed had offered to lend Treasury securities in exchange for ordinary AAA-rated mortgage-backed securities as collateral.
Chris Whalen, of the financial consultancy Institutional Risk Analytics in New York, said: “The Fed move is confirmation that at least one of the banks is in trouble. A huge part of the banks' inventories are illiquid. If a broker-dealer is illiquid, it dies.”
Speculation has swirled for months about the collapse of an American bank as the credit crisis has escalated and spread from sub-prime to other mortgage-backed securities, treasuries and bonds. As well as Bear Stearns, attention has focused on UBS, the Swiss bank, which has been forced to make more than $18 billion in sub-prime writedowns, and Citigroup, the world's largest financial institution, which has turned to sovereign wealth funds to help to shore up its credit-stricken balance sheet.
Bankers say that mortgage lenders, such as Paragon, Alliance & Leicester and Bradford & Bingley, could also be teetering on the brink soon if they cannot raise enough money in the markets to continue to lend to customers. All the banks have denied that they are facing a cash crunch and each has said that its liquidity position is strong. Nonetheless, the speculation continues to mount. Alan Schwartz, the Bear Stearns chief executive, reiterated that stance yesterday after Punk Ziegel analysts gave warning that the bank could be forced to seek a merger partner.
“We don't see any pressure on our liquidity, let alone a liquidity crisis,” Mr Schwartz told CNBC yesterday. He said that Bear had finished fiscal 2007 with $17 billion of cash sitting as a“liquidity cushion”. He added: “That cushion has been virtually unchanged. We're in constant dialogue with all the major dealers, and I have not been made aware of anybody not taking our credit.”
Yet banking sources said yesterday that a collapse seemed inevitable. One senior banker in London said: “Someone will go under in this crisis, that's for sure. The question is whether they stay under or get rescued. Let's see whether this latest round of stabilisation helps, but if it doesn't, it's difficult to see what Plan B is. The Fed can't just keep on printing money.”
One problem with the credit crunch is that banks' solvency positions can change overnight. As banks force firesales of assets to recover their loans from hedge funds, the prices of those assets fall. But as the prices fall, the amount of capital that the banks need rises. Lena Komileva, a Tullett Prebon economist, said: “This is what is fuelling the vicious cycle. Things can deteriorate very rapidly and banks can reach insolvency almost overnight.”
Ms Komileva said it was clear that the Fed was reacting to address a “specific counterparty risk”, although she declined to comment on which bank might be in trouble. She said: “The speed and severity of their action appeared disproportionate to what had actually happened, so, consequently, it seems the Fed really reacted to prevent a Northern Rock-style problem in the US.”
She said that the Fed's moves amounted to window-dressing. “All the signs of stress that were there before are still here,” she said.