The worst crisis in the money markets for two decades could come to a head this week when over £50 billion of IOUs come up for refinancing with the prospect of no buyers in sight. It is only a matter of time before the turmoil in the markets trickles down to the real world of mortgages and consumer spending.
The huge amount of “commercial paper” becoming due is the hangover from the crisis in credit markets that began with American sub-prime mortgages (see earlier story in knowledgebase). Many of the so called “structured investment vehicles ” (SIVs) set up by the banks were financed in the form of asset-backed commercial paper which is not included on their balance sheets.
Now, even if banks succeed in rolling over some of this paper this week, they will eventually be forced to take much of of it onto their balance sheets because no buyers can be found. And no buyers can be found because it is suddenly of questionable (if any) value. In anticipaton of this liability, banks are hoarding cash and have stopped lending to each other.
Commercial paper is typically taken up by pension and insurance funds. But under the current circumstances many of them are refusing to buy any more. It is the combination of this buying and lending strike that has created the liquidity freeze.
The prospect of serious market disruption from this maturing commercial paper is furhter exacerbated by £190 billion of loans and bonds to be laid off from leveraged buyouts and other private-equity deals at a time when the markets have shifted sharply against the banks.
In the short term, this credit crunch is forcing up the cost of borrowing and the Bank of England is concerned that this could spill over into the wider economy, making it difficult for businesses to raise long-term finance and possibly even affecting the mortgage market as lenders become more cautious about who they lend money to.
The situation is compounded by the fact that, because these deals can be re-packaged and sold on many times, no one is sure who holds the “toxic paper” as these debts have been dubbed. Britain’s big banks have varying degrees of exposure but nothing on the scale of the USA.
The refinancing of the commercial paper is expected to start tomorrow and end on September 20 and even more increased market volatility is expected during this 10 day period.
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