10/7T10:04 News and notes

Libor for overnight dollar loans jumps as credit freeze deepens - Bloomberg.com
Bloomberg.com reports the cost of borrowing in dollars overnight in London jumped as U.K. lenders held talks with the government on emergency funding and Iceland nationalized its second-biggest bank amid an unprecedented credit squeeze. The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94% today, the British Bankers' Association said. The corresponding rate for euros climbed 22 basis points to 4.27%, the highest in four days. The Tokyo interbank rate stayed at the highest level this year and the Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record... The Libor-OIS spread, the difference between the three- month dollar rate and the overnight indexed swap rate, climbed 2 basis points to 290 basis points today. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.
RCM Comment: The barometer continues to fall as the storm worsens. The majority of loans in this country are based on LIBOR as LIBOR has gradually replaced the prime rate as the lending benchmark.

Fed sets floor below rate target, engineering 'stealth' cut - Bloomberg.com
Bloomberg.com reports the Federal Reserve may have trimmed borrowing costs yesterday without actually saying so. The central bank used power granted under last week's financial-rescue legislation to effectively set a floor under its main interest rate that's lower than the 2% target set by policy makers last month. The Fed may now pay interest on bank reserves while it floods financial markets with liquidity, pushing down the overnight lending rate by about 0.75 percentage point to 1.25%... By paying interest on reserves, the Fed can pump more cash into the financial system without worrying the overnight lending rate will drop to zero at the end of each day as banks withdraw excess reserves. The move doesn't preclude a further reduction in the target rate by the Federal Open Market Committee

Fed says creates commercial paper funding facility to provide liquidity to term funding markets

Fed looks to ease strains in commercial-paper market - WSJ
WSJ reports U.S. officials are examining ways to ease deepening strains in the commercial paper market, which have been hit by an unwillingness among money market investors to hold risky assets. The move could involve the Federal Reserve making an unusual foray into unsecured lending. The Fed has been flooding financial markets with loans in recent months, but those loans are secured by collateral. In mid-September, the Fed unveiled a new lending program aimed at helping U.S. banks finance purchases of a kind of commercial paper called asset backed commercial paper, which is secured by collateral such as securities backed by mortgages or car loans. The move was aimed at stabilizing money market funds that were being forced to dump illiquid or risky holdings as investors redeemed their money. Some commercial paper brokers lamented that the Fed's backstop for the ABCP market may have at the same time reduced investor demand for unsecured commercial paper issued by many foreign banks and companies. So officials, who see strains in short-term funding markets as a dangerous development, are looking for ways to backstop this market, too.
RCM Comment: After reading the previous three stories you may experience an olfactory sensation. Have no fear, it is just the smell of paper burning. The cure for this condition is the knowledge that you have significant Gold holdings in your portfolio.

CME CME Group and Citadel confirm plans to launch the first integrated Credit Default Swaps trading platform and central counterparty facility (403.85 ) CME and Citadel Investment Group announced they have executed a non-binding term sheet to launch a joint venture company within 30 days, which will be the first electronic trading platform that is fully integrated with a central counterparty clearing facility for Credit Default Swaps (CDS). CME Clearing, the world's largest derivatives clearing house, will be the central counterparty for this solution. The joint venture will operate as an independent organization with its own board of directors and management team.
RCM Comment: This story may actually be a development worth watching as it could help the situation. The main question will revolve around whether or not anyone can make sense and a market out of the existing tangled web of CDSs. Electronic exchanges can only trade securities that are based on a set of common standards. For example, Puts and Calls are traded based on a specific set of rules creating uniformity in the contracts. The multi-trillion Credit Default Swaps (CDSs) outstanding are individual contracts between two counterparties that have no uniformity. How the new exchange deals with this problem should be amusing to watch and in our opinion difficult if not impossible to accomplish.

The Saga Continues...
Iceland PM says have been talking to Russia about loan; will be sending people to Moscow Wed or Thus

Iceland guarantees domestic bank deposits amid crisis; S&P lowers ratings - Bloomberg.com
Iceland's government pledged to guarantee all domestic bank deposits and gave regulators the power to take over bank assets and appoint new boards to obtain funds from lenders that may become ``inoperable.'' ``In the current situation it is every country for itself,'' Prime Minister Geir Haarde told a press conf today in Reykjavik, after failing to negotiate foreign loans for a broader bailout of the nation's banking system. ``We want to save what can be saved.'' The government's efforts are aimed at ensuring that deposits at Kaupthing Bank hf and Landsbanki Island hf are protected from bank debts that have reached about 12 times the size of the Atlantic Ocean island's economy. The krona has plunged 31% against the dollar in the past 30 days on concern the global credit crisis would cripple the banks and bankrupt the country. Standard & Poor's cut the nation's sovereign credit rating for a second time in as many weeks. ``It is too risky for the Icelandic nation as a whole to secure a lifeline for the banks,'' Haarde said in a television address. ``The danger is real that the Icelandic economy would be sucked, along with banks, under the waves and the nation would become bankrupt.'' A bill presented to parliament today authorizes the financial supervisory authority to take control of commercial banks' assets and appoint boards, Haarde said. ``I would like to defuse all doubts that deposits by Icelanders and private pension savings in all Icelandic banks are not secure,'' Haarde said in a television address. ``No-one need be in any doubt about that.'' No mention was made of deposits held at Icelandic banks' foreign subsidiaries. ``The interests of the nation are greater than the interests of the individual banks,'' Haarde said. ``We in the government are only acting with the interests of the nation in mind, even if it means that harsh measures have to be taken against those with vested interest. When a situation like this comes up the shareholders suffer damage, in this situation it is to be expected that some lenders' claims will not be met.'' Today's bill also allows the state-backed Housing Financing Fund to take over banks' mortgage operations. The liquidity crisis has sent Iceland's currency into a tailspin as a shortage of credit batters economies reliant on debt. Iceland had a current account deficit equal to 34% of gross domestic product in Q2, according to combined central bank and statistics office data, with most of the shortfall coming from the cost of sustaining foreign debt payments. Late yesterday, Haarde said Kaupthing and Landsbanki, Iceland's biggest banks, and the country's pension funds would sell overseas assets and repatriate the proceeds in a bid to bolster the krona and alleviate the credit crunch. Today, though, that proposal had faded. ``Last night it looked like the banks could manage,'' Haarde said.