Britain masterminded this week's central bank effort to avert a liquidity crunch, its central bank chief said on Thursday, laying claim to the genesis of a plan that began to take shape around 10 days ago and was ready by the weekend.
Bank of England governor Mervyn King said he instigated the move by the central banks of the United States, euro zone, Japan, Canada, Britain and Switzerland to provide cheaper dollar funding for starved European banks, which provided a longed-for fillip to market sentiment.
It was the result of conversations which I initiated as chairman of what used to be known as the G10 governors, now the economic consultative committee, among a limited number of central banks, he told a news conference in London.
But let me stress, this cannot be a solution to the underlying crisis, all this can do, is to help temporarily relieve liquidity problems. But liquidity problems, often, reflect underlying solvency problems and in this case they do.
The U.S. Federal Reserve and European Central Bank (ECB) started seriously discussing Wednesday's move around the middle of last week, one European banking source said, and the Federal Reserve's policy panel held a videoconference on Monday to discuss cutting the interest rate for dollar swap lines.
Another source said provisional agreement was reached in a teleconference at the start of last week, that by the end of the week details had been agreed, and a date of Wednesday November 30 set for the announcement.
Whatever King's role was, the ECB has been watching the creeping credit freeze with growing alarm for more than half a year but its interventions -- lending banks in the euro zone half a trillion euros -- have so far failed to overcome fears they could be sucked under by a sovereign debt crisis.
Two years into Europe's crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, deposits are draining from southern European banks and a looming recession is fuelling doubts about the survival of the euro.
Federal Reserve officials have been quick to point out that
the cheaper dollar swap lines, intended to ensure banks outside the United States have ready access to dollars, are not intended to bail out Europe -- but help shore up economic growth.
...there is not so much leverage out there in the market right now, so if we do see the banking system freezing up, you might not see much forced selling but it would impact the global economy in a very big way, said Kathleen Gaffney of Loomis Sayles, a part of Natixis Asset Management.
With dollar funding strains compounded by regulatory pressure, European banks have preferred to shore up balance sheets than fork out for dollar funding.
But most large banks also have dollar assets and liabilities. With interbank rates rising as concerns grow about the funding ability of counterparties, European banks have been effectively cut out of dollar markets. This has already prompted some European banks to dispose of U.S. denominated assets - and sparked concerns that trade with the U.S. could be at risk.
The growing signs of stress in the European financial system can be seen most clearly in the 'TED spread' - the difference between interest rates on interbank loans and short-term government bills, and a widely followed measure of the perceived risk attached to lending to banks, Andrew Cole, Investment Director at Baring Asset Management said.
This is still a long way from the very high levels seen when Lehman Brothers failed, but has been moving steadily higher in recent months and is indicative of the concern about bank credit ratings which has been impeding both inter-bank lending and lending in the wider economy, Cole added.
The crisis has already prompted European banks to halt lending and start selling assets. But they are particularly keen to dispose of assets in U.S. dollars, where funding is most tight, seeing them pullback in areas like project finance, shipping finance, aviation and infrastructure.
For banks with big U.S. operations, or which tend to lend for projects denominated in dollars, like the French banks, this has been a particular problem.
Dollar funds have been made available via the ECB, but they are expensive and tapping the central bank carries stigma.
The funding crunch in Europe is far greater than simply a dollar issue, however, as banks in Europe's crisis hotspots such as Greece have found themselves shut out of the interbank market needed to fund their day to day operations.
Even getting access to backstop funding options, such as ECB funding facilities, is becoming a problem as banks fret about running out of eligible securities they can use to tap these, or collateral. Banks are busy hoarding what securities they can to cash in at the ECB.
This is Lehmans take two. Cubed, said Gaffney.
(Additional reporting by Sarah White and Sinead Cruise in London; Writing by Kirstin Ridley; Editing by Alexander Smith and Andrew Callus)