JEFFREY BROWN: And we take a closer look now at today’s move and the reaction with Catherine Mann, professor of economics at the Brandeis International Business School. She served previously on the Federal Reserve Board of Governors. And David Smick, a global economic policy strategist and author of the book “The World is Curved: Hidden Dangers to the Global Economy.”
Catherine Mann, I will stall start with you.
Fill in the picture a bit. What exactly is the problem that the central banks were trying to address?
CATHERINE MANN, Brandeis University International Business School: Well, what they were trying to address was that it’s become more expensive since the summer, actually, for banks to borrow from each other in the overnight market.
And that’s the way that banks fund themselves, is that they borrow in the overnight market from each other. And since the summer, we have been looking at the interest rate that they charge each other has been rising and rising and rising. It’s now at a level or was earlier today at the level right before the crisis with Lehman Brothers.
And so the central banks were looking at this really expensive cost of banks borrowing from each other as really an indicator of the amount of stress that was happening and the lack of trust between banks since they weren’t going to lend to each other. So that’s really what they were trying to address here.
It’s a narrow bank-to-bank funding question, but, of course, from that narrow place, you get into a lot of difficulty on lending more broadly to companies and to businesses.
JEFFREY BROWN: Well, so, David Smick, the markets, well, they loved it, 490 points. What did they see?
DAVID SMICK, “The World is Curved: Hidden Dangers to the Global Economy”: Well, you can’t deny — any time a 4 percent increase in equity market happens, it’s significant, but not — probably not as significant as we’d like.
I agree with Catherine. This was about trust. And I think it’s confusing for a lot of people. What’s going on here is that in the summer, the European banks decided they didn’t trust each other. And the interbank market froze. So the European Central Bank said, we well into the interbank market.
And so everything worked fine until just the last week or so, when suddenly the European banks said we don’t trust the European Central Bank. We’re not sure it’s going to be around the ways things are going.
JEFFREY BROWN: They don’t trust each other because they don’t know how much of their own problems are connected to…
DAVID SMICK: Part of it is, too, yes, there’s so much — there’s like a web of interconnectivity, but they are not — but what’s interesting now is that the global central banks, led by the Fed, said, well, do you trust us? And if they don’t trust the world central banks collectively, then we have a problem.
But I think it was successful, in that what you have right now is massive amount of liquidity around the world sitting on the sidelines with very cheap equity markets. So any time there’s a little bit of positive news, you see this explosion in stock markets, and because it’s so cheap and there’s so much money just sitting there ready to move.
JEFFREY BROWN: Catherine Mann, what would you add to about why the markets just took off like that?
CATHERINE MANN: Well, the markets have been — the markets are basically run by algorithmic trading these days or traders. Nobody’s making investments in the stock market thinking they’re getting a long-term investment in the company that they’re buying a stock for.
So all we’re looking at is trading on news. This was big news. And so when the market opened here in the United States, the market just responded to that news in a very positive way. I think, though, that one of the downsides of this additional liquidity being put into the global marketplace is that it provides more ammunition for the traders in the marketplace who want to bet against the central bank — or against the European Central Bank in particular, or want to bet against some of those sovereign governments in Europe that are running some difficulties.
So this excess liquidity or a lot of liquidity does have a downside. And I think that we aren’t thinking exactly how that ammunition is going to be used. We’re thinking it’s going to be used for good, but there’s no guarantee that it’s going to be used for good.
JEFFREY BROWN: Well, David Smick, I mean, it goes to this larger question of Europe which we have talked about so many times on the program.
Today’s action, how much does it address or not address those deeper problems?
DAVID SMICK: Well, it really is a sideshow.
If you look at today and you say, when’s the last time that the global central banks got together, it was three days after the Lehman crisis in 2008.
JEFFREY BROWN: That was a big moment.
DAVID SMICK: And you know what? The stock market, the Dow went up 6 percent, not 4 percent.
The problem is that for the next three months, global stock markets dropped 30 percent, and growth globally, including in the U.S., fell off the table. The problem is, this is a sovereign — a solvency problem in Europe, not a liquidity problem. The — you have a 5 trillion euro solvency problem that has to be financed by at least, it looks like, 6 percent, sometimes 7 percent or higher.
And that is going to put enormous strain on the Europeans. So I would look at it and say they haven’t really solved the problem of solvency. They have got this nice little takeoff. It’s a reprieve, but we’re really back to square one in dealing with the problem.
The other thing that I would say is, I — I think that the people who are selling Europe and have been in the last few weeks are not traders in New York, hedge funds, speculators, because they’re barred from doing it. The people who are selling European sovereign debt right now are the Europeans.
The European banks are selling themselves, because they’re saying, we don’t have confidence in our leadership.
JEFFREY BROWN: Yes.
Now, Catherine Mann, what about the American risk here? I mean, it was enough to get the Federal Reserve involved, right?
CATHERINE MANN: Well, I think that the fact that this was a coordinated effort I think is important, because it does take the spotlight off of any individual nation state or individuals, national financial institutions, that, oh, we’re going to try to help them in particular.
But it is a fact that the foreign branches of — or the U.S. branches of foreign banks — in other words, they’re a European bank, they have a branch in New York — they are ones who are — were particularly tight in being able to get funding, because the U.S. banks that were sitting around them in New York were closest to the accident waiting to happen.
And so they were the ones that were most restrictive in their willingness to lend to those U.S. branches of foreign banks. But I do want to go back to the issue of whether or not this is just a Band-Aid and is really not addressing the underlying problem in Europe.
It’s very similar to the type of intervention that the central banks did before Lehman. And then, of course, we have additional problems after that. The central bank intervention that was coordinated at the time didn’t solve the underlying problems of the housing market.
Similarly, this intervention in Europe is not going to solve, it doesn’t even come close to addressing the political problem that they face there, that it’s a fiscal problem. National governments have spent too much money, they have borrowed too much over a long period of time. And for Greece in particular, there has to be some write-down of that — those debt obligations, those so-called haircuts.
JEFFREY BROWN: All right, very brief…
CATHERINE MANN: … the European fund…
JEFFREY BROWN: OK. Very brief last word.
DAVID SMICK: It’s a little bit like the house is on fire, and…
CATHERINE MANN: Right.
DAVID SMICK: But, also, the pluming is backed up. Well, today, we took care of the plumbing, but the house is still on fire.
JEFFREY BROWN: All right, markets were happy with better plumbing, but we’re going to continue to watch the house — well, I hope not burn down.
CATHERINE MANN: The house burn down, yes.
JEFFREY BROWN: Catherine Mann and David Smick, thank you both very much.
DAVID SMICK: Thanks.
CATHERINE MANN: You’re welcome.