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Friday, September 2, 2011

Central bank flight to Federal Reserve safety tops Lehman crisis

Graph: Factors Absorbing Reserve Funds - Reverse Repurchase Agreements - Foreign Official and International Accounts

A key warning signal of global financial stress has shot above the extreme levels seen at the height of the Lehman crisis in 2008.

Central banks and official bodies have parked record sums of dollars at the US Federal Reserve for safe-keeping, indicating a clear loss of trust in commercial banks.

Data from the St Louis Fed shows that reserve funds from "official foreign accounts" have doubled since the start of the year, with a dramatic surge since the end of July when the eurozone debt crisis spread to Italy and Spain.


"This shows a pervasive loss of confidence in the European banking system," said Simon Ward from Henderson Global Investors. "Central banks are worried about the security of their deposits so they are placing the money with the Fed."

These dollar accounts are just over $100bn (£62bn) and are small beer compared to the vast sums invested in bonds as foreign reserve holdings. Yet they serve as stress indicator, reflecting the operating decisions of the world's top insiders.

The dollar data refers specifically to reverse repurchase agreements.

Lars Tranberg from Danske Bank said European banks are reduced to borrowing dollar funds for "a week at a time" rather than the usual six to 12 months. "This closely resembles what happened in late 2008, though the difference this time is that the major central banks have dollar swap lines in place. If the dollar funding markets completely freeze up, the European Central Bank can act as a backstop."

Mr Tranberg said dollar deposits of US banks have increased by $400bn since mid-June, mostly offset by dollar reductions in Europe. "It is clear that the problem lies with the European banks. The credit default swaps on these banks are very high and provide a risk gauge."

The Bank for International Settlements says European and British banks have a dollar "funding gap" of up to $1.8 trillion stemming from global expansion during the boom that relies on dollar financing and has to be rolled over. This is not normally a problem but funding can seize up in a crisis.

European officials hotly disputed claims in a leaked document from International Monetary Fund claiming that a realistic "mark-to-market" of Italian, Spanish, Greek, Irish, Portuguese and Belgian sovereign debt would reduce the tangible equity of Europe's banks by €200bn (£176bn).

"French banks passed stress tests which were extremely tough less than a month ago: there is no cause for worry," said Valerie Pecresse, France's budget minister.

"It is ill advised to provoke alarm," said Michael Kummer, head of Germany's BdB bank federation.

The IMF was attacked as a Cassandra when it warned early in the credit crisis that debt write-downs would reach $600bn, yet losses have since reached $2.1 trillion.

European banks are still struggling to access America's $7 trillion money market funds. Fitch Ratings said last week that Spanish and Italian banks have been cut off altogether.

Investors do not fully believe EU pledges that the 21pc "haircut" agreed for private holders of Greek debt is the end of the story, or will remain confined to Greece, as the second Greek rescue is already unravelling. A Greek parliament report concluded that deep recession is pushing the country into a downward spiral, causing debt dynamics to fly "out of control". Public debt will reach 172pc of GDP next year.

Simon Derrick from BNY Mellon said Germany, Holland, and Finland may balk at a third rescue in the current tetchy mood, implying bigger haircuts instead. That will set a precedent for Portugal, and others. Until markets can see an end to the blood-letting, Europe's banks will remain untouchables.
The Telegraph

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