As Israel’s attack on Gaza enters its third week, almost a thousand Palestinians have died, 40% among them women and children. In terms of the recent decrease in the number of Hamas’ rockets lobbing into the land of Israel, Ehud Barak’s, Israel’s defense minister, “Cast Lead Operation” can claim to have been succeeded. Nevertheless, the conflict is unlikely to end any time soon. Instead of stop shelling Palestinian schools and hospitals which are allegedly hiding Hamas combatants, Israel is expanding its military power onto the ground, and even moving reserve troops to the border. With dozens of civilians being killed and hundreds being wounded each day, International pressure on ceasefire is mounting.
To most people, Israel’s military operation is unjust. The sheer scale of its killing tells. From July last year to the start of the war, 4 Israelis had been killed by rockets fired by Hamas. To stop its innocent citizens from being hurt, Israel started the war, and in less than twenty days, it has killed nearly a thousand, most of them innocent non-combatants. Although the Israel government claims that it only attacks military targets, a lot of ordinary infrastructure has been bombed, including a UN school and a main hospital. Blackouts are now everywhere in Gaza. The cities are running out of food and clean water. And with sewage spilling onto the streets, hundreds of thousands of people are now under an impending risk of a widespread epidemic.
Since the start of the war, Israel has been condemned by much of the international community, including the United Nations and the European Union, for starting a war without enough justification. It is thus hard to believe that Israel has been stepping up its military actions day after day. Behind the scene of course is the silent endorsement from Washington. As a matter of fact, the United States certainly would like to see Hamas’ military power being crushed. It is because that would deal a hard blow to Iran, which is supporting the arming of Hamas. President-elect Barack Obama’s remarkably silence in the issue speaks to the point.
If we agreed that the conflict is not going to end soon, then the next question is, where will it go? Would Israel continue bombing until Hamas is forced into submission? Or would a mounting death toll of civilians force Israel into stopping it under diplomatic pressure? Would Obama’s coming into office bring anything new onto the diplomatic table? But no matter what, the hundred-year conflict between the Jews and the Arabs in the Middle East will only get worse before it get better.
Ever since the establishment of the Israel nation in 1948, bloodshed and killing has never stopped for a day in Jerusalem, Gaza and the West Bank. The fundamental reason is that the two people, the Jews and the Palestinians, are fighting for the same patch of land. Although it comes obvious to outsiders that since they cannot share the land, a partition, a two-state solution is the only way out, the two sides have never come together and negotiated terms on that. The most promising moment came at the turn of the century when Bill Clinton held a summit at Camp David. But unfortunately, no substantial progress had been made. The prospect of the two sides agreeing terms became even dimmer when Hamas won the election in 2006 against Fatah, the less combatant Palestinian organization that has a lot of support both inside and outside the Middle East. Against this backdrop, one may argue that Israel’s operation will lead to a weakened Hamas which make peace talks between Israel and the Palestinians less difficult. However, this line of reasoning misses an important point: although Hamas’s combatant power may well be temporarily diminished, the killing and bloodshed only makes it much easier to recruit ever more combatants and gain more support from the Arab world.
Tuesday, January 13, 2009
Monday, January 5, 2009
The aftermath of financial crises
In a recent research report titled "The Aftermath of Financial crises", Professor Reinhart from the University of Maryland and Professor Rogoff from the Harvard University investigate how past financial crises affect economies both in the industrial world and in the emerging world.
They gather statistics on house prices, equity prices, employment, output and government debt and adopt a comparative historical methodology to show that, in contrary to what many economists believe, there are a lot in common between the rich world and the emerging markets in the ways their economies are hit by banking crises.
In particular, the study singles out three characteristics. First, assets prices suffer deep and prolong declines. Housing prices fall an average 35 percent while equity prices plunge by 55 percent on average. The average duration of the drop is more then 4 years. Second, unemployment soars by an average 7 percentage points and output goes down by an average 9 percentage points. And notably, job losses in the rich world are in general much more severe than that in the emerging markets. The researchers attribute it to two factors: More flexible downward adjustment of wages and gaps in social safety net which makes job-losers more anxious to find new jobs. Also, the durations of declines in employment and output are also shorter than that of asset prices, below 2 years in general. Third, government debt soars by an average 86 percent in the aftermath of banking crises, mainly because of the inevitable decreases in tax revenues and big spending on counter-cyclical fiscal stimulation instead of the much more minor costs of bailing out financial institutions and recapitalizing them.
The study conclude by discussing how relevant it is to predicting the track of the current global financial crisis. Unfortunately, the geographical extent of the current crisis is rare in history and there are very few examples to learn from. with exception to the Great Depression, the crises covered are regional in nature which affect only a few countries or countries within a continent. In contrast, the crisis we are facing today started in the U.S. and has since then spread to West Europe, East Europe, Asia and Latin America. In a regional crisis, affected countries can grow their way out by exporting more and borrowing more. However, when the world economy take a hit all at the same time and credits are crunching everywhere, that is not feasible. In light of this, what would be more effective is massive fiscal stimulus. Therefore, countries with healthy budget surpluses and current-account surpluses and take the initiative to stimulate their economies will likely be the ones who recover first.
They gather statistics on house prices, equity prices, employment, output and government debt and adopt a comparative historical methodology to show that, in contrary to what many economists believe, there are a lot in common between the rich world and the emerging markets in the ways their economies are hit by banking crises.
In particular, the study singles out three characteristics. First, assets prices suffer deep and prolong declines. Housing prices fall an average 35 percent while equity prices plunge by 55 percent on average. The average duration of the drop is more then 4 years. Second, unemployment soars by an average 7 percentage points and output goes down by an average 9 percentage points. And notably, job losses in the rich world are in general much more severe than that in the emerging markets. The researchers attribute it to two factors: More flexible downward adjustment of wages and gaps in social safety net which makes job-losers more anxious to find new jobs. Also, the durations of declines in employment and output are also shorter than that of asset prices, below 2 years in general. Third, government debt soars by an average 86 percent in the aftermath of banking crises, mainly because of the inevitable decreases in tax revenues and big spending on counter-cyclical fiscal stimulation instead of the much more minor costs of bailing out financial institutions and recapitalizing them.
The study conclude by discussing how relevant it is to predicting the track of the current global financial crisis. Unfortunately, the geographical extent of the current crisis is rare in history and there are very few examples to learn from. with exception to the Great Depression, the crises covered are regional in nature which affect only a few countries or countries within a continent. In contrast, the crisis we are facing today started in the U.S. and has since then spread to West Europe, East Europe, Asia and Latin America. In a regional crisis, affected countries can grow their way out by exporting more and borrowing more. However, when the world economy take a hit all at the same time and credits are crunching everywhere, that is not feasible. In light of this, what would be more effective is massive fiscal stimulus. Therefore, countries with healthy budget surpluses and current-account surpluses and take the initiative to stimulate their economies will likely be the ones who recover first.
Monday, December 1, 2008
Economist Debate
On Economist.com, two Nobel-prize winners in Economics debate the motion "it would be a mistake to regulate the financial system heavily after the crisis". Professor Myron S. Scholes, the proposition, argues that deregulation since the 1970s have brought staggering increase in wealth and prosperity globally and a heavy-hand regulation will stifle innovations that are key to long-term growth. Professor Joseph Stiglitz, the opposition, counters that financial crises have become more frequent and more severe in the deregulation era. On the innovation point, he highlights that much of the creativity is directed to circumventing regulations and regulatory arbitrage, instead of making the economy more efficient and helping ordinary people. He suggests that inadequate regulation plays a large role in the current crisis.
Scholes argues for a light-hand regulation that would continue to encourage financial innovations. In his point of view, those who propose re-regulation failed to measure the staggering increase in global wealth and income brought to us by financial innovations since deregulation started in 1970s. On the other hand, more regulation would not prevent financial crisis from happening. Banks and broker-dealers have gone bust in countries with heavy regulation on the financial system. Even worse, incorrect regulations often have unintended consequences which add fuels to financial bubbles. Therefore, the matter is not whether to have more or less regulation, but to have better regulation.
The current crisis which sparked off from subprime mortgages deteriorated rapidly because financial institutions have gone leveraging too far and left their capital bases very weak. In light of this, Scholes proposes regulation on requiring that financial institutions meet stricter capital requirements. He is careful to provide detail arguments to weigh the pros and cons of this approach. Citing classical research results in Economics, he points out that although additional equity capital will diminish a firm's expected return on equity, it would not affect the enterprise's value. It is because with additional equity capital, the capital to debt ratio is improved and this, in turn, results in reducing risk of the equity. In other words, expected return on equity is lowered but the return-to-risk tradeoff is unaffected. Scholes concludes that instead of adopting a heavy-hand regulatory approach which almost always does more harm than good, simply requiring banks to boost their capital base is much more efficient and flexible. And flexibility in regulation is necessary for innovations.
After going through Scholes' main arguments, let's have a look at what Stiglitz said.
Professor Stiglitz believed that inadequate regulation is at least as well a reason of the current financial crisis as bad regulation. In particular, he pointed out that the Fed have not employed the full regulatory power it has to keep the financial system healthy until it is too late to remedy. In his words, this is "the unsurprising consequence of appointing as regulators people who only half believe in regulation". He admits that the current regulatory framework is not perfect, but as Paul Volcker once remarked that "even a leaky umbrella can be helpful in a rainstorm", an equally relevant point to inadequate regulation is that current regulators, who ironically doubts regulations, have not made good use of what is already available. Noting that collapses in the financial sector, in addition to doing harm within Wall Steet, always hurts innocent bystanders as the economy plunges into a recession or a depression and they lost their jobs. As a result of this, those whose interest are more unaligned with that of Wall Street should have a larger voice in regulation in the future.
On the benefits of deregulation, Stiglitz remarks that there is no strong evidence in supporting that deregulation since the 1970s led to the increase in global wealth since then. In contrast, what is much more evident is that financial crises have become much more frequent and serious since then, with the largest happening at the moment. He argues that innovations are more often directed at gaming the regulatory system instead of making capital allocations more efficient. Instead of providing valuable services to the economy, Wall street bankers make hard efforts in "predatory lending", taking advantage of the asymmetric information they have against ordinary people, reaping enormous bonuses by lending to those who cannot afford. What happens now is that householders are forced out of their homes, houses are built in nowhere, and capital is massively misallocated and wasted.
Stiglitz argues that inadequate regulation plays a large role in crisis and more regulation is needed to prevent it from happening again. He highlights a regulatory framework which includes corporate governance, accounting methods, incentive structures, speed limits and lending practices. He also proposes setting up a "safety commission" of financial products which would encourage the kind of innovations that make our economy more efficient and discourage those that serve Wall Street in sacrificing Main Street.
He shares commonground with Scholes that the matter is better regulation rather than more of less regulation. However, he believes that much more regulations have to be reformed because they have shown themselves to be too inadequate.
Scholes argues for a light-hand regulation that would continue to encourage financial innovations. In his point of view, those who propose re-regulation failed to measure the staggering increase in global wealth and income brought to us by financial innovations since deregulation started in 1970s. On the other hand, more regulation would not prevent financial crisis from happening. Banks and broker-dealers have gone bust in countries with heavy regulation on the financial system. Even worse, incorrect regulations often have unintended consequences which add fuels to financial bubbles. Therefore, the matter is not whether to have more or less regulation, but to have better regulation.
The current crisis which sparked off from subprime mortgages deteriorated rapidly because financial institutions have gone leveraging too far and left their capital bases very weak. In light of this, Scholes proposes regulation on requiring that financial institutions meet stricter capital requirements. He is careful to provide detail arguments to weigh the pros and cons of this approach. Citing classical research results in Economics, he points out that although additional equity capital will diminish a firm's expected return on equity, it would not affect the enterprise's value. It is because with additional equity capital, the capital to debt ratio is improved and this, in turn, results in reducing risk of the equity. In other words, expected return on equity is lowered but the return-to-risk tradeoff is unaffected. Scholes concludes that instead of adopting a heavy-hand regulatory approach which almost always does more harm than good, simply requiring banks to boost their capital base is much more efficient and flexible. And flexibility in regulation is necessary for innovations.
After going through Scholes' main arguments, let's have a look at what Stiglitz said.
Professor Stiglitz believed that inadequate regulation is at least as well a reason of the current financial crisis as bad regulation. In particular, he pointed out that the Fed have not employed the full regulatory power it has to keep the financial system healthy until it is too late to remedy. In his words, this is "the unsurprising consequence of appointing as regulators people who only half believe in regulation". He admits that the current regulatory framework is not perfect, but as Paul Volcker once remarked that "even a leaky umbrella can be helpful in a rainstorm", an equally relevant point to inadequate regulation is that current regulators, who ironically doubts regulations, have not made good use of what is already available. Noting that collapses in the financial sector, in addition to doing harm within Wall Steet, always hurts innocent bystanders as the economy plunges into a recession or a depression and they lost their jobs. As a result of this, those whose interest are more unaligned with that of Wall Street should have a larger voice in regulation in the future.
On the benefits of deregulation, Stiglitz remarks that there is no strong evidence in supporting that deregulation since the 1970s led to the increase in global wealth since then. In contrast, what is much more evident is that financial crises have become much more frequent and serious since then, with the largest happening at the moment. He argues that innovations are more often directed at gaming the regulatory system instead of making capital allocations more efficient. Instead of providing valuable services to the economy, Wall street bankers make hard efforts in "predatory lending", taking advantage of the asymmetric information they have against ordinary people, reaping enormous bonuses by lending to those who cannot afford. What happens now is that householders are forced out of their homes, houses are built in nowhere, and capital is massively misallocated and wasted.
Stiglitz argues that inadequate regulation plays a large role in crisis and more regulation is needed to prevent it from happening again. He highlights a regulatory framework which includes corporate governance, accounting methods, incentive structures, speed limits and lending practices. He also proposes setting up a "safety commission" of financial products which would encourage the kind of innovations that make our economy more efficient and discourage those that serve Wall Street in sacrificing Main Street.
He shares commonground with Scholes that the matter is better regulation rather than more of less regulation. However, he believes that much more regulations have to be reformed because they have shown themselves to be too inadequate.
Sunday, October 26, 2008
Absolute return – but only when the market goes up
Hedge fund managers have always claimed that they possess investment skills that can produce absolute returns no matter how the market weather. Investors in hedge funds obviously believed in this when they were willing to be charged several percentage points of the returns as management fees. It is now almost one year after the Dow Jones saw its peak around 14,000 and it has seen fallen by a scaring 40%. Oil is also down more than 50% from its peak and many other commodities have performed even worse. Against the backdrop of global fire-sales of asset, the typical hedge funds seemed to have done not too poorly: it has lost 20% in a year. But it definitely hasn’t lived up to its promise of generating absolute returns.
Why have hedge funds fared so badly? Most of the fund managers point their fingers at the ban on short-selling of financial stocks in recent weeks. Being able to sell short is necessary for hedge funds to hedge away the risks in their portfolios. So when the government abruptly banned short-selling, it prompted a simultaneous fire-sales of suddenly non-hedgeable risky assets. This hurts everybody and particularly hedge funds which employ the “convertible arbitrage” style, the type of hedge fund that lost most, 42%, a year to now. However, although the ban can partly explain why this September was the worst month for hedge funds since statistical data is available, it cannot explain why hedge funds have been constantly losing money in each month since the credit crunch broke out last summer.
The sudden disappearance of cheap money is one obvious cause. Skeptics have long argued that the huge returns of hedge funds come from nothing but leveraging on mediocre returns. When credit stopped flowing and interest rates went up to the roof, hedge funds’ interest costs surged and they had to liquidate some of their positions when re-financing became impossible.
Another plausible suspect, who naturally has not been blamed by fund managers, is their own client. When hedge fund first became popular in the 1990s, most of their assets under management came from super-rich individuals and banks. These are mainly loyal investors who do not ask their money back when times are bad. But as hedge funds become more and more known to the public, the picture is now totally different. Among the $2 trillion assets under management, almost 40% of them came from funds-of-hedge-funds which are the first to leave in the prospect that something bad may happen. The past month alone has seen a worrisome withdrawal of $20 billion from the industry. Most hedge funds employ strategies that require them to stay in the positions long enough to make profits. They are thus indeed hit hard by their own clients.
If the markets bounce back, capital may as well once again flow back to hedge funds. It is thus hard to say the current credit crisis would lead to a debacle of the whole industry. But certainly, as the promise of absolute returns is not realized, their clients would make the business much less profitable by demanding a reduction in performance fees.
Sunday, October 19, 2008
Regulation or Deregulation
Capitalism has never been so challenged since the Great Depression. And state interventions in markets now seem the only way out. Without the American and European governments buying stakes in banks and lending directly to corporates, the credit market would seemed to be clogged forever. And consequently much more businesses would go bankrupt and unemployment would soar and a depression would be certain. Alan Greenspan, the former Fed Chairman, has always claimed that deregulation is a main driver for the past two decades of fast growth in the U.S. How true it is we are not certain. But obviously, many of the root causes of the current crisis come from not regulating the financial system properly. The important question for the future is, how big a role should the government play in the market.
With the scale of the mess seen in past weeks, those in favor of more regulation is quickly gaining ground. It is true to certain extent that regulations can stop financial instutions from taking excessive risks, but they may also have unintended consequences which encourage risk taking. For example, the Basel Accord requires banks to put a portion of capital as reserves to cushion against bad times. This by all means seem an effective method as it restrains banks from putting all its capital at stake. However, what happened was that financial firms come up with innovations to move the risky assets off balance sheets and take advantage of it as far as possible. It is one reason why securitization of mortgages, collateralizated debt obligations and credit default swaps have become so popular in recent years.
So the correct question is not asking how much regulation we need, but how to regulate better. In terms of this, one principle stands out: transparency. The main reason why banks now are not lending to each is the opacity of banks' financial health. Counterpary risk is hard to estimate when toxic assets are held off balance sheets. Therefore, a reform of accouting rules requring disclosure of highly risky assets is necessary. But that is still not enough because these assets are often complexly strctured and hard to price fairly. As models that are accepted industry-wide can only be found in Alice's wonderland, a better and simpler solution is to restrain the exposure of banks to these opaque products.
Without doubt, the regulations can hurt banks' profitability, in short term. But it is now evident that excessive profitability in the short term often is the preclude to going bust in the near term.
With the scale of the mess seen in past weeks, those in favor of more regulation is quickly gaining ground. It is true to certain extent that regulations can stop financial instutions from taking excessive risks, but they may also have unintended consequences which encourage risk taking. For example, the Basel Accord requires banks to put a portion of capital as reserves to cushion against bad times. This by all means seem an effective method as it restrains banks from putting all its capital at stake. However, what happened was that financial firms come up with innovations to move the risky assets off balance sheets and take advantage of it as far as possible. It is one reason why securitization of mortgages, collateralizated debt obligations and credit default swaps have become so popular in recent years.
So the correct question is not asking how much regulation we need, but how to regulate better. In terms of this, one principle stands out: transparency. The main reason why banks now are not lending to each is the opacity of banks' financial health. Counterpary risk is hard to estimate when toxic assets are held off balance sheets. Therefore, a reform of accouting rules requring disclosure of highly risky assets is necessary. But that is still not enough because these assets are often complexly strctured and hard to price fairly. As models that are accepted industry-wide can only be found in Alice's wonderland, a better and simpler solution is to restrain the exposure of banks to these opaque products.
Without doubt, the regulations can hurt banks' profitability, in short term. But it is now evident that excessive profitability in the short term often is the preclude to going bust in the near term.
Monday, October 13, 2008
Unprecedented bailouts in historic times
Governments in both the U.S. and Europe had failed to restore confidence in financial markets until today. Last week, in spite of the co-ordinated half-percentage-point rate cut by the central banks and various aggressive bail-out packages, the costs of overnight interbank borrowing broke record every day and stock markets around the world had slumped by more than 20 percent. The fire sales seemed never-ending.
After the G7 nations gathering last weekend, the governments in the industrialized nations at last found themselves determined to rescue the financial system. The Fed and the European Central Bank pledged to provide unlimited amount of liquidity, in dollars and in euros, respectively, to unclog the credit markets. The European governments in total came up with a bail-out package of more than $2 trillion. Britain will inject capital directly into its ailing banks and guarantee any new debt they issue. Other European countries are likely to follow suit. The Treasury of the U.S. had also started discussion about buying stakes in banks, in contrast to its strong disapproval of it in the past weeks. With all the efforts, the G7 officials announce that they will "use all means to prevent a systematic collapse of the global banking system."
Stockmarkets around the world soared on Monday after the news, with the Dow Jones making the biggest percentage-point gain since the Great Depression. Investors rush back as they see investment values in stocks after the fire-sales last week. However, it is too early to claim that confidence is back. Although the stock market has bounced back strongly, the spreads in the credit markets are still near record highs. Moreover, as housing prices in both continents are unlikely to hit bottom soon, mortgage-related losses will continue to stress the financial system. With thier unprecented moves, the governments may be able to avert a severe global depression. But a global recession is now without doubt.
After the G7 nations gathering last weekend, the governments in the industrialized nations at last found themselves determined to rescue the financial system. The Fed and the European Central Bank pledged to provide unlimited amount of liquidity, in dollars and in euros, respectively, to unclog the credit markets. The European governments in total came up with a bail-out package of more than $2 trillion. Britain will inject capital directly into its ailing banks and guarantee any new debt they issue. Other European countries are likely to follow suit. The Treasury of the U.S. had also started discussion about buying stakes in banks, in contrast to its strong disapproval of it in the past weeks. With all the efforts, the G7 officials announce that they will "use all means to prevent a systematic collapse of the global banking system."
Stockmarkets around the world soared on Monday after the news, with the Dow Jones making the biggest percentage-point gain since the Great Depression. Investors rush back as they see investment values in stocks after the fire-sales last week. However, it is too early to claim that confidence is back. Although the stock market has bounced back strongly, the spreads in the credit markets are still near record highs. Moreover, as housing prices in both continents are unlikely to hit bottom soon, mortgage-related losses will continue to stress the financial system. With thier unprecented moves, the governments may be able to avert a severe global depression. But a global recession is now without doubt.
Sunday, October 5, 2008
Money Market still Frozen
The $700 billion mortgage-rescue plan was unexpected rejected by the House on Monday. The stockmarket then was immediately in panic. The Dow Jones industrial average slumped by more than 400 points in 10 minutes after the result of the vote was shown on TV screens, and eventually plunged by 778 points, its largest point drop ever.
The shock from the House prompted Henry Paulson, the treasury secretary, and Ben Bernanke, the chairman of the Fed, to make more concessions on the bail-out. These include capping executives' pay in rescued institutions and increasing the limit of the Federal Deposit Insurance from $100,000 to $250,000. With these changes and more effortful lobbying, the Senate passed the bill in the middle of the week and the House finally passed it on Friday. However, confidence did not seem to be restored. After the bail-out plan was approved, the DJIA first gave up its 200+ gains and finally ended down more than 150 points.
One big problem to worry about is the money market. In the wake of the collapse of so many financial institutions in such a short period of time, banks are now extremely reluctant to lend money to each other for more than an overnight in fear of counter-party risk. This pushes the spread of LIBOR over the Treasury rates to more than 4 percentage points. Even credityworthy institutions are now paying punitive rates to get their necessary funding.
After seeing collapses of financial institutions all over the continent, the European money market has become even more clogged than the American one. In usual times, banks and investors arrange foreign-exchange swaps to get their needed funds in dollars or euros. But the market is now completely dried up. To help dealing with the problem, the Federal Reserve provided a credit line of $620 billion to its counterpart, the European Central Bank, for lending dollars to European banks. At first glance, it may look like a back-door bailout. However, there is a big difference with respect to the collateral the banks need to put at the central bank. In the American bail-out plan, or the TARP, troubled mortgage-related assets would be accepted as colleteral. In contrast, the European Central Bank would only accept colleteral of much higher quality. Moreover, the Fed in fact is lending directly to the ECB and so there is no real credit risk.
The shock from the House prompted Henry Paulson, the treasury secretary, and Ben Bernanke, the chairman of the Fed, to make more concessions on the bail-out. These include capping executives' pay in rescued institutions and increasing the limit of the Federal Deposit Insurance from $100,000 to $250,000. With these changes and more effortful lobbying, the Senate passed the bill in the middle of the week and the House finally passed it on Friday. However, confidence did not seem to be restored. After the bail-out plan was approved, the DJIA first gave up its 200+ gains and finally ended down more than 150 points.
One big problem to worry about is the money market. In the wake of the collapse of so many financial institutions in such a short period of time, banks are now extremely reluctant to lend money to each other for more than an overnight in fear of counter-party risk. This pushes the spread of LIBOR over the Treasury rates to more than 4 percentage points. Even credityworthy institutions are now paying punitive rates to get their necessary funding.
After seeing collapses of financial institutions all over the continent, the European money market has become even more clogged than the American one. In usual times, banks and investors arrange foreign-exchange swaps to get their needed funds in dollars or euros. But the market is now completely dried up. To help dealing with the problem, the Federal Reserve provided a credit line of $620 billion to its counterpart, the European Central Bank, for lending dollars to European banks. At first glance, it may look like a back-door bailout. However, there is a big difference with respect to the collateral the banks need to put at the central bank. In the American bail-out plan, or the TARP, troubled mortgage-related assets would be accepted as colleteral. In contrast, the European Central Bank would only accept colleteral of much higher quality. Moreover, the Fed in fact is lending directly to the ECB and so there is no real credit risk.
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