More On Liquidity, Credit & Monetary Policy

As discussed in the 8/08 post below, financial liquidity
is plentiful when viewed yr/yr, with the M-3 proxy ahead
by 9.2%. However, over the past three months broad
liquidity increased at only a 4.4% annual rate, as banks
capped off real estate exposure. Since a faster growing
real economy claimed the past three months' modest liquidity
increase, the financial markets have been squeezed. As
suggested last week, the Fed would have to be alert to the
squeeze. They were not alert enough and had to inject over
$60 billion in reserves in short order.

There are credit issues out there beyond the crummy real
estate loans. Spikes in overnight lending rates as occured
last week spell mismatches in deposit and payment flows
within the banking system and daylight overdraft problems.
That says late arriving money and stepped up redemption
requests from risky portfolios that cannot produce firm
NAV and are drawing on credit lines. Today we learn that
Coventree, a junior sized Canadian finance house could not
roll over its asset backed commercial paper and was forced
to extend. So, beside a liquidity squeeze, we have some
crunch in the credit sector.

As a former chief investment officer at a major money center
bank, it has been my distinct pleasure to sit through
bankerly meetings when the spit has hit the fan o'er lending.
The dumb guys who made the bad loans now do not want to
make good loans. The CEO sics the chief credit officer on
loan officers who have earned special contempt. The economist
is brought in to do his routine. Folks are marked for termination.
There is near endless paper shuffling and procrastination.
Finally, someone will inquire whether the lights should be
turned off and all go home for good. After a bit, people get
working to adopt policies sensible to the times. The bank
moves forward, no longer seized up and ready to implement the
new marching orders. Bad credits get dumped and the good
credits get taken out to lunch. We're not there yet in the
system.

The Fed has belatedly added a large measure of liquidity. It
remains to be seen how much they take back and how much they
leave on the table. The Fed has leeway to leave plenty on the
table without creating an inflationary surge as it has been
tightfisted with reserves for three years running.

Difficult moments in the credit markets take time to work out.
Smarter more decisive guys do not get the upper hand on the
dunderheads overnight. But progress will come.