Velshi: Banks' move a coordinated effort to help Europe buy time
The euro symbol is seen in front of the European Central Bank in Germany.
November 30th, 2011
09:38 AM ET

Velshi: Banks' move a coordinated effort to help Europe buy time

Editor's note: The U.S. Federal Reserve, acting with other nations' central banks, took steps Wednesday to support the global financial system with a coordinated plan to lower prices on dollar liquidity swaps beginning on December 5, and extending these swap arrangements to February 1, 2013. CNN's chief business correspondent Ali Velshi takes a look at why they may have made the move and how it can help the struggling European banks temporarily.

This major coordinated global move was undertaken because a global credit freeze - the likes of which we haven't seen since just after the collapse of Lehman Brothers in Sept of 2008 - was looking entirely possible.

By way of background, the cost (or rate) for European banks to borrow dollars from other European banks has skyrocketed since May and, in some cases, banks haven't been able to borrow for short periods (overnight to three months) at all.

Under international banking rules, banks must end each day with a certain reserve. As a matter of course, they lend each other money through a largely automated system on a nightly basis to cover any short-term shortfalls. Increasingly, with fears that over-leveraged banks could have a "run on the bank" and the lending bank might not be repaid, banks are hesitant to make short-term loans to other banks. If they do, it's at a premium rate.

The net follow-on effect is that under-capitalized banks stop offering short-term credit facilities to their clients. (Think of how clothing purchases are financed: Retailers don't pay cash to suppliers - a bank pays the suppliers, then gets cash from the retailer as sales are made.) As clients find it more difficult to raise much-needed daily operating cash from banks, they need to immediately slash cash expenditures. Generally, the easiest way to do that is to lay people off.

In an attempt to stave off the consequences of a global credit freeze, the Federal Reserve, in coordination with major central banks, has created a credit line available to those central banks, whereby they can borrow dollars at reduced interest rates for periods of three months. The central banks, in turn, can lend to commercial banks in their respective countries. This is meant to reduce the cost of short-term borrowing for troubled European banks and to give them immediate access to dollars.

This was done immediately after the collapse of Lehman Brothers as well, to alleviate the consequences of banks being largely unwilling to lend to other banks, even for short periods, for fear that the borrowing banks could fail.

This is a serious development that doesn't solve an underlying problem of bank instability. It buys time for banks to try to find solid footing for themselves.

Quest: Banks' move helps but doesn't address fundamental eurozone problems

And, in case you were wondering, it is an instance of the creation of "moral hazard" - a term in economic theory for a situation where there's an incentive to share a risk - as the central banks have jointly decided that some shaky European banks may be "too big to fail."

soundoff (108 Responses)
  1. shugie

    I think I see the problem. Apparently the world markets should have been listening to you morons.

    December 1, 2011 at 7:35 am | Report abuse |
  2. Bianca

    They have told us for at least 30 years of the goodness of globalization. This religion is still upon us, every one in media telling the same story - just more money! Let everyone approve more money! Let Germany throw caution to the wind, and leverage their banks to the hilt! Let the money go into the central banks - whereever they are - and pump the money into the fat banks around the globe. Let the money go to all the favorite people and their political eneblers. No accounting, no questions to be asked. In Europe, GOVERNMENTS CANNOT borrow from their "central Bank", only banks can - at a low rate! Just like here! Banks can continue speculating, continue the drunken ball - until the collapse. They have no incentives to stop, nothing to loose and everything to gain. Are we the fools!

    December 1, 2011 at 7:49 am | Report abuse |
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    December 1, 2011 at 10:08 am | Report abuse |
  4. Matt

    European countries are in denial – they have been pursuing a utopian idea and now they are trying to avoid the inevitable. They can only delay the demise of euro for a short while. The sooner the countries leave euro, the sooner they will be able to get their economy in shape.

    December 1, 2011 at 10:38 am | Report abuse |
  5. Ethan

    Ron Paul 2012

    December 1, 2011 at 1:31 pm | Report abuse |
  6. ME

    Just a guess, but by...say 2060, 2080, it wont surprise me if a large part of civilization (most likely the US at this point) has collapsed

    December 1, 2011 at 2:56 pm | Report abuse |
  7. ME

    Scratch that, I wouldn't be surprised if half the world will go completely to hell by 2090

    December 1, 2011 at 3:00 pm | Report abuse |
  8. haremettle

    @r....your position is so hold no regard for the other poor slobs in the world that have to have the left overs of what we waste. The world has changed forever and you cant go back to 1985. It's gone like a soldier in the civil war. I mean if you don't mind stepping on the necks of the rest of the world, then yea, OK we could do that. But we'll burn in hell for it and eventually, we or our children would have to pay for it here on earth.

    December 1, 2011 at 4:06 pm | Report abuse |
  9. cutey 635889

    i dont understand it im only 11

    December 1, 2011 at 7:13 pm | Report abuse |
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