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Interbank hysteria

• Robert Peston
• 24 Sep 08, 04:26 PM

Until money markets go wrong, the rest of us barely know they exist.

But something has gone seriously awry in the interbank market, which is where banks lend colossal sums to each other.

The measure of what's gone wrong is the record gap of almost 1 ½ percentage points - or 145 basis points to be precise - between the interest rate for lending between banks in sterling for three months (what's called three month Libor) and the market's expectation of the average overnight interest rate for the coming three months (or the three month OIS rate).

The gap has never been as wide as that, though it has periodically been over one percentage point since the credit crunch began last August.

Before the crunch, the average gap was 0.1 percentage points (10 basis points).

What that gap shows is that banks are happy to lend for 24 hours, but not for any longer than that.

In fact, banks have more money to lend overnight than they know what to do with.

They are depositing a ton of it with the Bank of England in its standing deposit facility, which pays a paltry penal interest rate of 4%.

Think about that for a second.

Our banks are prepared to lend to the Bank of England overnight at 4%, but not to each other for three months at more than 6%.

What on earth is going on?

Well the background is that banks are rebuilding their balance sheets to cope with the economic downturn we're experiencing, and they're doing that by lending less (and raising new capital).

But the more immediate cause is a sudden flare up - post the debacles at Lehman, AIG and the rest - of fears that no financial institution is safe from collapse.

So bank chief executives and treasurers think it's wiser to hoard cash (or liquidity) than to lend it out, even if that leads to a reduction in profits (which it does).

Also, there's a significant potential funding problem for all banks in the growing risk aversion of US money market mutual funds, which are increasingly reluctant to lend their trillions of dollars for more than a few days at a time (because they were burned on Lehman and because their shareholders are withdrawing cash on a significant scale).

The rise in interbank rates for lending longer than overnight is the most palpable sign of crisis in the global banking system, a crisis engendered principally by fear.

Banks aren't fulfilling their core function, of transmitting money to where it's needed.

It's why and may not be guilty of hyperbole when they claim that their $700bn banking bailout plan may be the difference between life and near death for the global financial economy.

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France bets huge on Britain

• Robert Peston
• 24 Sep 08, 12:40 PM

For those who fear we're in danger of talking ourselves into an irredeemably deep and dark depression about the prospects for our economy, 's acquisition of our can be seen as a powerful message of hope.

The financial commitment being made to the UK by the French state-controlled utility is enormous, in a literal sense.

It may represent the biggest ever overseas investment in the UK, when the various bits are added together.

In round numbers, EDF is paying a touch over €15bn for 's existing assets.

It will spend a further €10bn over the coming 15 years on the construction of four new nuclear generators (the first of which is scheduled to open at Christmas 2017 - and the other three in a rolling programme over the following five years or so).

And it will invest €400m a year maintaining British Energy's existing generators.

That represents an aggregate investment of around €30bn - or £24bn - from now to around 2020, in today's money.

It's a spectacular vote of confidence from La Republique no less that the United Kingdom is anything but bust.

Of course, if the deal goes through as planned, the owner of British Gas will take on a quarter of that massive financial commitment.

But that deal is not done. And as of this moment, EDF is on the hook for €30bn.

The deal demonstrates that power, especially reliable energy that doesn't emit C02, is almost the most precious thing on earth right now.

But it also shows that there should be plenty of vibrant economic life, once we're through le Crunch (whenever that'll be).

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British banks shorted

• Robert Peston
• 24 Sep 08, 08:44 AM

Prime ministers probably shouldn't use phrases they don't understand.

Gordon Brown, seconds ago, attacked "naked short-selling" on the , and then went on to describe short-selling covered by borrowed stock (viz short-selling that's not naked).

For next time, prime minister, what you're criticising is all short-selling, not the racier clotheless variety.

Perhaps I'm being pedantic, but these sorts of semantic errors are becoming slightly pathological (go back to the for more Brown malapropisms on the market).

While we're on the subject of shorting, the scariest disclosure of the past 24 hours was that John Paulson has made bets of around £1bn that the share prices of our biggest banks are on their way down.

He's the hedge-fund megastar, the founder of New York's , who made several billions last year short-selling collateralised debt obligations.

If he thinks our banks are almost as structurally flawed as investments created out of subprime rubbish, well that's not altogether reassuring.

As for the widespread suggestion that has just announced a great vote of confidence in the US investment banking system by injecting $5bn into , don't make me laugh.

He's demanded, and is receiving, a lovely 10% dividend, which means he views Goldman as a high-risk investment.

This is very expensive money for Goldman, not least because if it wants to buy Buffett out, it has to pay a 10% premium.

And on top of that he gets a warrant to purchase $5bn of common stock which can be exercised at any time in the next five years.

In other words, the world's biggest and most fearsome investment bank has just had its pocket picked by a 78-year-old (albeit the canniest 78-year-old on the planet).

Strange times.

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