Helios Padilla Mayer

On November 25, the US Treasury and FED unveiled a $800 billion lending program to shore up the consumer-finance market: the central bank will buy up to $600 billion in debt issued or backed government-chartered housing finance-companies and it will also set up a $200 billion program to support consumers and small-business loans. In addition, Treasury will provide $20 billion of credit protection to the Federal Reserve in connection with its $200 billion Term Asset Backed Securities Loan Facility. This step was necessary as the Fed and other central banks had to interchange their function of “lenders of last resort” into the “lenders of first and only resort” as interbank lending market is virtually standstill, banks do not lend to non-financial institutions and financial institutions do not lend to the household and corporate sector.

However, despite these actions, a serious of problems remains unsolved on short-term money markets: (1) The Libor-OIS spread, a measure of cash scarcity among banks, was at 178 basis points on November 26 and the TED-spread (the difference between what banks and the Treasury pay to borrow money for three months) was at 208 basis points, whereas in normal conditions spreads are around 10-20 basis points. (2) Only banks and major broker dealers have access to Fed facilities; most of the shadow banking system does not benefit from this Fed liquidity. (3) The availability of short term credit is becoming tighter as banks increase interest rates on credit cards, student loans and auto loans. (4) Only rated investment grade corporate have access to the commercial paper facility while speculative grade or non-rated firms remain in credit squeeze. (5) Currently there is no securitization of credit cards, auto loans and student loans.

On November 26, the European Commission announced its European Economic Recovery Plan proposal, which calls for a targeted and temporary fiscal stimulus of around €200 billion or 1.5% of EU GDP, within national budgets of around €170 billion and EU and European Investment Bank budgets of around €30 billion. The Stability & Growth Pact will be eased temporarily which will stimulate EU members to engage into the fiscal stimulus which could lead to a temporary surpass of a budget deficit of 3% of national GDP. The Plan will be presented for approval by EU leaders at their summit in Brussels on 11-12 December.

Although this plan is ambitious, the lack of incentives for collective action in the EU could undermine the effectiveness of economic stimulus. For example, German and French leaders already rejected a coordinated cut in VAT as the one announced by the UK only 2 days before the EU Plan announcement.

^{1) Term used in Portes, Richard and Daniel Cohen (2006), “Toward a Lender of First Resort”, IMF Working Paper 06/66.
2) http://ec.europa.eu/commission_barroso/president/pdf/Comm_20081126.pdf}

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