http://www.adweek.com/aw/index.jsp
yesterday
For my Classes' edification
Monday, 13 October 2008
Advertising Campaigns
Top 100 from Ad Age
http://adage.com/century/campaigns.html
Dove campaign
http://www.campaignforrealbeauty.com/
AD Council of America historic campaigns
http://www.adcouncil.org/default.aspx?id=61
http://adage.com/century/campaigns.html
Dove campaign
http://www.campaignforrealbeauty.com/
AD Council of America historic campaigns
http://www.adcouncil.org/default.aspx?id=61
Ten tips on branding
Ten tips on branding
To build a successful brand you should:
Focus on what your business achieves for its customers. Your brand is no good to you if it isn't delivering what customers want.
Take ownership of your brand. Pay attention to customers' needs, but you should still control what you want your brand to mean to them.
Be honest. If you don't believe in your brand, no one else will.
Keep your brand simple by focusing on a small number of key brand values.
Be consistent. Every aspect of your business should make customers feel the same way about you.
Be thorough. Look at all your systems to make sure they help to support your brand.
Involve employees. Make sure they understand your brand and believe in it.
Communicate your brand. Make sure every advertisement, brochure and letter helps reinforce the same message. If you have a logo, use it everywhere, but make sure the quality is consistent.
Meet and exceed what your brand promises. Failing, just once, will damage your brand.
Manage your brand. Continually look for opportunities to make improvements. And don't be afraid to make changes to reflect shifts in the way you do business or new trends in your market.
New Zealand tarminology resources
Classroom Resources
Terminology
- English Online resource - International site - NZ site
Conversation Terminology
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Exploring Cartoons
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The Language of Advertising
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The Language of Debating
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The Language of Film
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The Language of Literary Analysis
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The Language of Oratory
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Glossary of Poetic Terms
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Grammatical Knowledge for Teachers From the UK National Literacy Strategy, a series of modules for teachers to update or consolidate their basic grammatical knowledge. Currently two of these five modules are available: * grammatical overview * word classes
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Handbook of Poetic Terms An online handbook of poetic terms. Five sections cover the basics; paradox and personification, ambiguity and consonance, rhythm, meter, stanzas, and verse forms.
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The Internet Grammar of English Designed primarily for undergraduate university students, other students and teachers will find this site very useful. It is divided into word classes, phrases, clauses and sentences, form and function and includes both explanations and exercises.
Search for similar resources
KS 3 Grammar A simple, clear guide for students and teachers to sentence level grammar (eg word classes and families, sentences and clauses etc), text level grammar (eg coherence, person and viewpoint, tense and time etc) and punctuation and grammar.
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A List of Fallacious Arguments From ad hominen to internal contradiction to weasel words.
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NetLingo NetLingo is an online dictionary about the Internet. It contains thousands of words and definitions that explain the technology and community of the World Wide Web, e-mail, chat, and newsgroups.
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Whatis.com Visit this site for a concise definition of a technical term (plus lots more).
Search for similar resources
Your Dictionary.com This is not just a fast and easy-to-use dictionary/thesaurus but also a gateway to language dictionaries, speciality dictionaries, word games, language tools and more.
Search for similar resources
http://english.unitecnology.ac.nz/resources/links/resource_query.html?area=Terminology&no_levels=1&sitearea=Classroom
Terminology
- English Online resource - International site - NZ site
Conversation Terminology
Search for similar resources
Exploring Cartoons
Search for similar resources
The Language of Advertising
Search for similar resources
The Language of Debating
Search for similar resources
The Language of Film
Search for similar resources
The Language of Literary Analysis
Search for similar resources
The Language of Oratory
Search for similar resources
Glossary of Poetic Terms
Search for similar resources
Grammatical Knowledge for Teachers From the UK National Literacy Strategy, a series of modules for teachers to update or consolidate their basic grammatical knowledge. Currently two of these five modules are available: * grammatical overview * word classes
Search for similar resources
Handbook of Poetic Terms An online handbook of poetic terms. Five sections cover the basics; paradox and personification, ambiguity and consonance, rhythm, meter, stanzas, and verse forms.
Search for similar resources
The Internet Grammar of English Designed primarily for undergraduate university students, other students and teachers will find this site very useful. It is divided into word classes, phrases, clauses and sentences, form and function and includes both explanations and exercises.
Search for similar resources
KS 3 Grammar A simple, clear guide for students and teachers to sentence level grammar (eg word classes and families, sentences and clauses etc), text level grammar (eg coherence, person and viewpoint, tense and time etc) and punctuation and grammar.
Search for similar resources
A List of Fallacious Arguments From ad hominen to internal contradiction to weasel words.
Search for similar resources
NetLingo NetLingo is an online dictionary about the Internet. It contains thousands of words and definitions that explain the technology and community of the World Wide Web, e-mail, chat, and newsgroups.
Search for similar resources
Whatis.com Visit this site for a concise definition of a technical term (plus lots more).
Search for similar resources
Your Dictionary.com This is not just a fast and easy-to-use dictionary/thesaurus but also a gateway to language dictionaries, speciality dictionaries, word games, language tools and more.
Search for similar resources
http://english.unitecnology.ac.nz/resources/links/resource_query.html?area=Terminology&no_levels=1&sitearea=Classroom
The top ten viral ad campaigns
The top ten viral ad campaigns
Adverts so good people choose to watch them? Send them to their friends, even? Times Online reports on what makes viral ads infectious
The internet has revolutionised a plethora of pastimes: the way people communicate, find dates, commit crimes, you name it, (Rhys Blakely writes). But the business of selling stuff and of building brands continues to see one of the most radical tranformations.
At the cutting edge is the viral campaign; the short video clip that is so compelling much of an advertiser’s work is done for them when their prospective customers forward it to their contacts quickly building up an audience of millions.
A whole new industry has sprung up, dedicated to unravelling what makes viral ads infectious. GoViral, for instance, specialises in launching viral campaigns – in part by ”seeding” clips on the web in places where they are picked up by the online populace.
What once was much a matter of luck is slowly being transformed into a science. Jimmy Maymann, the group’s chairman, has built a polling system, ”which every campaign is taken through prior to launch in order ensure virality”.
The ideal campaign is edgy, surprising, original, erotic and emotional – and taps into popular culture, he says. His system attempts to quantify these elements.
Below, Mr Maymann presents ten of the richest viral videos on the web today.
NIKE
This clip is one of the all time greatest virals ever, with more than 50 million views globally. Featuring world famous soccer star Ronaldinho hitting the crossbar no less than four times, without the ball touching the floor. The creative material is from Framfab, in Denmark. The product on display is the Nike R10 football boot. A massive discussion on whether the clip was actually real or computer edited drove millions of interested viewers to the campaign.
Framfab won two Gold Lions on the Cannes Lions Festival for the campaign. The other winning clip was The Chain, a user generated initiative, consisting of more than 500 user uploaded soccer sequences edited together as one long clip of soccer celebration.
To watch the ads click here:
http://www.youtube.com/watch?v=lsO6D1rwrKc
http://nikefootball.nike.com/nikefootball/siteshell/index.jsp#,en,0;chainmix
AGENT PROVOCATEUR
Kylie Minogue rides a velvet bucking bronco wearing nothing but lingerie from Agent Provocateur.
This video was originally meant for a cinema audience, but after being judged too explicit it went viral and started spreading aggressively throughout the internet.
The video is completely in harmony with the Agent Provocateur corporate vision to provoke and create controversy, which it most definitely did, with more than 360 million views – and still counting – more than five years after its release.
http://uk.youtube.com/watch?v=HztQbRpKcMo
JOHN WEST SALMON
A John West employee fights a grizzly bear off to land a fish – just to go that extra mile for quality. Obviously, it is set up, but with costumes from the Jim Henson Creature Shop it looks surprisingly real, until the bear starts throwing Kung Fu tricks at the “fisherman”.
An unusual viral, it created more than 300 million views and has won ten awards, including Best Commercial of the Year from British Television Advertising Awards and a Gold Lion at the Cannes Lions Festival, 2001. Executed by Leo Burnett, the viral brings together the best of advertising and content in one.
http://www.youtube.com/watch?v=zOpKFPEah3E
QUICKSILVER DYNAMITE SURFING
How to go surf in a country without waves: a group of young men throw a bundle of dynamite into an urban lake. Whether the clip was real or not was never really discovered, a factor that itself garnered attention.
The creative agency was Danish Saatchi & Saatchi and the client was Quiksilver, trying to create positive brand awareness in Scandinavia. It has so far been watched by more than 20 million people. Four days after launch, it appeared on approx. 95 per cent of all surfer related websites. The viral won a Silver award at this year’s Cannes Lions.
http://uk.youtube.com/watch?v=6xfBNxNds0Q
BIG AD
The Carlton Draught Big Ad is an award-winning advertisement for Carlton Draught created by George Patterson and Partners (Young & Rubicam) of Melbourne, which used viral marketing techniques before being released on television.
The advertisement was released on the internet two weeks before being shown on television. Just 24 hours after release, the Big Ad had been downloaded 162,000 times and within two weeks it had been seen by over one million viewers in 132 countries. That number has since grown at least twentyfold. The viral release of the Big Ad was in fact so successful that the television media budget was reduced for fears the ad would be overexposed.
http://uk.youtube.com/watch?v=aWDNy43ATjc
TROJAN GAMES
In 2003, to launch Trojan Condoms in the United Kingdom, the "official" web site for the so-called "Trojan Games" was created with several clips by UK-based The Viral Factory.
The campaign received several awards including best online creative of the year in the Creative Showcase and also a Gold Lion at the 51st International Advertising Festival in Cannes.
The site, and especially the associated video clips, were quite popular, having been viewed 35 million times. Now four years old the site is still active.
http://uk.youtube.com/watch?v=AbTSmOS_m6Q
DOVE EVOLUTION
Already a classic, even though it is one of the newest campaigns in this selection. Ogilvy & Mather, Toronto, used time-lapse photography to show the transformation of an normal woman into a glamorous billboard model using beauty stylists and Photoshop enhancements. The clip was released under the slogan “No wonder our perception of real beauty is distorted”.
Dove Evolution took top honours in both the Cyber and Film categories on this year’s Cannes Lions pointing to the colliding worlds of consumer-powered digital distribution and brand building. It's the first time in the festival's history that the same execution won in both categories, an even more impressive achievement if you consider that this huge success was almost single-handedly was achieved using online seeding. Only very few times has the commercial been aired on television.
It is fast becoming one of the most watched videos on the internet. In the two years since Dove decided to brand itself as the beauty company that celebrates real beauty that strategy has rewarded the company with double digit sales increases.
http://uk.youtube.com/watch?v=iYhCn0jf46U
BERLITZ – WHAT ARE YOU ZINKING ABOUT?
A viral video campaign featuring a language difficulty in a European coastguard station.
The ad was developed by BTS United Oslo, and originally pointed to a web site where people could download it and send it to their friends, as well as navigating through to Berlitz Norway. The response was so large that Berlitz was forced to shut down the site.
By now - more than a year after the launch of the viral - the clip is represented in more than hundred versions on Youtube alone.
http://www.youtube.com/watch?v=FrYRY6kx550
DIET COKE & MENTOS BY EEPYBIRD.COM
This campaign was never planned, neither by The Coca Cola Company nor Mentos. It started out as an experiment by Eepybird with a video showing two men adding Mentos tablets to a Diet coke. Watch to see the results. Several videos resulted, which makes it difficult to estimate exactly how many views the campaign has generated so far. But a qualified guess would be more than 50 million in total, including both the original and all the user generated videos.
This very unofficial campaign has generated loads of PR and causing thousands of consumers to contribute with their own eruption videos. Much of the hype around it was caused by statements whether or not it would be dangerous, or even lethal, to actually drink a Diet Coke and eat Mentos at the same time.
Eepybird’s website
Spoof site
MARK ECKO – STILL FREE
The best virals usually lead to massive attention and, in some cases, controversy and outrage. This is exactly what happened to Mark Ecko. Having started several enterprises around the hip/hop, skater and style scene, Ecko decided to create a ideological statement on the First Amendment. He filmed a session of himself ”tagging” Air Force One and used the following hype to explain why. Did he really spray grafitti on the President’s jet? Judge for yourself by following the link below.
The Still Free campaign has generated several million views worldwideThe US authorities felt compelled to investigate whether it was ”real”. The video was rewarded several awards at the International Advertising Festival in Cannes, 2006 including the famous and very difficult to achieve Grand Prix award in the Viral Marketing category.
www.stillfree.com
http://business.timesonline.co.uk
Adverts so good people choose to watch them? Send them to their friends, even? Times Online reports on what makes viral ads infectious
The internet has revolutionised a plethora of pastimes: the way people communicate, find dates, commit crimes, you name it, (Rhys Blakely writes). But the business of selling stuff and of building brands continues to see one of the most radical tranformations.
At the cutting edge is the viral campaign; the short video clip that is so compelling much of an advertiser’s work is done for them when their prospective customers forward it to their contacts quickly building up an audience of millions.
A whole new industry has sprung up, dedicated to unravelling what makes viral ads infectious. GoViral, for instance, specialises in launching viral campaigns – in part by ”seeding” clips on the web in places where they are picked up by the online populace.
What once was much a matter of luck is slowly being transformed into a science. Jimmy Maymann, the group’s chairman, has built a polling system, ”which every campaign is taken through prior to launch in order ensure virality”.
The ideal campaign is edgy, surprising, original, erotic and emotional – and taps into popular culture, he says. His system attempts to quantify these elements.
Below, Mr Maymann presents ten of the richest viral videos on the web today.
NIKE
This clip is one of the all time greatest virals ever, with more than 50 million views globally. Featuring world famous soccer star Ronaldinho hitting the crossbar no less than four times, without the ball touching the floor. The creative material is from Framfab, in Denmark. The product on display is the Nike R10 football boot. A massive discussion on whether the clip was actually real or computer edited drove millions of interested viewers to the campaign.
Framfab won two Gold Lions on the Cannes Lions Festival for the campaign. The other winning clip was The Chain, a user generated initiative, consisting of more than 500 user uploaded soccer sequences edited together as one long clip of soccer celebration.
To watch the ads click here:
http://www.youtube.com/watch?v=lsO6D1rwrKc
http://nikefootball.nike.com/nikefootball/siteshell/index.jsp#,en,0;chainmix
AGENT PROVOCATEUR
Kylie Minogue rides a velvet bucking bronco wearing nothing but lingerie from Agent Provocateur.
This video was originally meant for a cinema audience, but after being judged too explicit it went viral and started spreading aggressively throughout the internet.
The video is completely in harmony with the Agent Provocateur corporate vision to provoke and create controversy, which it most definitely did, with more than 360 million views – and still counting – more than five years after its release.
http://uk.youtube.com/watch?v=HztQbRpKcMo
JOHN WEST SALMON
A John West employee fights a grizzly bear off to land a fish – just to go that extra mile for quality. Obviously, it is set up, but with costumes from the Jim Henson Creature Shop it looks surprisingly real, until the bear starts throwing Kung Fu tricks at the “fisherman”.
An unusual viral, it created more than 300 million views and has won ten awards, including Best Commercial of the Year from British Television Advertising Awards and a Gold Lion at the Cannes Lions Festival, 2001. Executed by Leo Burnett, the viral brings together the best of advertising and content in one.
http://www.youtube.com/watch?v=zOpKFPEah3E
QUICKSILVER DYNAMITE SURFING
How to go surf in a country without waves: a group of young men throw a bundle of dynamite into an urban lake. Whether the clip was real or not was never really discovered, a factor that itself garnered attention.
The creative agency was Danish Saatchi & Saatchi and the client was Quiksilver, trying to create positive brand awareness in Scandinavia. It has so far been watched by more than 20 million people. Four days after launch, it appeared on approx. 95 per cent of all surfer related websites. The viral won a Silver award at this year’s Cannes Lions.
http://uk.youtube.com/watch?v=6xfBNxNds0Q
BIG AD
The Carlton Draught Big Ad is an award-winning advertisement for Carlton Draught created by George Patterson and Partners (Young & Rubicam) of Melbourne, which used viral marketing techniques before being released on television.
The advertisement was released on the internet two weeks before being shown on television. Just 24 hours after release, the Big Ad had been downloaded 162,000 times and within two weeks it had been seen by over one million viewers in 132 countries. That number has since grown at least twentyfold. The viral release of the Big Ad was in fact so successful that the television media budget was reduced for fears the ad would be overexposed.
http://uk.youtube.com/watch?v=aWDNy43ATjc
TROJAN GAMES
In 2003, to launch Trojan Condoms in the United Kingdom, the "official" web site for the so-called "Trojan Games" was created with several clips by UK-based The Viral Factory.
The campaign received several awards including best online creative of the year in the Creative Showcase and also a Gold Lion at the 51st International Advertising Festival in Cannes.
The site, and especially the associated video clips, were quite popular, having been viewed 35 million times. Now four years old the site is still active.
http://uk.youtube.com/watch?v=AbTSmOS_m6Q
DOVE EVOLUTION
Already a classic, even though it is one of the newest campaigns in this selection. Ogilvy & Mather, Toronto, used time-lapse photography to show the transformation of an normal woman into a glamorous billboard model using beauty stylists and Photoshop enhancements. The clip was released under the slogan “No wonder our perception of real beauty is distorted”.
Dove Evolution took top honours in both the Cyber and Film categories on this year’s Cannes Lions pointing to the colliding worlds of consumer-powered digital distribution and brand building. It's the first time in the festival's history that the same execution won in both categories, an even more impressive achievement if you consider that this huge success was almost single-handedly was achieved using online seeding. Only very few times has the commercial been aired on television.
It is fast becoming one of the most watched videos on the internet. In the two years since Dove decided to brand itself as the beauty company that celebrates real beauty that strategy has rewarded the company with double digit sales increases.
http://uk.youtube.com/watch?v=iYhCn0jf46U
BERLITZ – WHAT ARE YOU ZINKING ABOUT?
A viral video campaign featuring a language difficulty in a European coastguard station.
The ad was developed by BTS United Oslo, and originally pointed to a web site where people could download it and send it to their friends, as well as navigating through to Berlitz Norway. The response was so large that Berlitz was forced to shut down the site.
By now - more than a year after the launch of the viral - the clip is represented in more than hundred versions on Youtube alone.
http://www.youtube.com/watch?v=FrYRY6kx550
DIET COKE & MENTOS BY EEPYBIRD.COM
This campaign was never planned, neither by The Coca Cola Company nor Mentos. It started out as an experiment by Eepybird with a video showing two men adding Mentos tablets to a Diet coke. Watch to see the results. Several videos resulted, which makes it difficult to estimate exactly how many views the campaign has generated so far. But a qualified guess would be more than 50 million in total, including both the original and all the user generated videos.
This very unofficial campaign has generated loads of PR and causing thousands of consumers to contribute with their own eruption videos. Much of the hype around it was caused by statements whether or not it would be dangerous, or even lethal, to actually drink a Diet Coke and eat Mentos at the same time.
Eepybird’s website
Spoof site
MARK ECKO – STILL FREE
The best virals usually lead to massive attention and, in some cases, controversy and outrage. This is exactly what happened to Mark Ecko. Having started several enterprises around the hip/hop, skater and style scene, Ecko decided to create a ideological statement on the First Amendment. He filmed a session of himself ”tagging” Air Force One and used the following hype to explain why. Did he really spray grafitti on the President’s jet? Judge for yourself by following the link below.
The Still Free campaign has generated several million views worldwideThe US authorities felt compelled to investigate whether it was ”real”. The video was rewarded several awards at the International Advertising Festival in Cannes, 2006 including the famous and very difficult to achieve Grand Prix award in the Viral Marketing category.
www.stillfree.com
http://business.timesonline.co.uk
Saturday, 4 October 2008
From Sept 25th
America’s bail-out plan
The doctors' bill
Sep 25th 2008 WASHINGTON, DC
From The Economist print edition
The chairman of the Federal Reserve and the treasury secretary give Congress a gloomy prognosis for the economy, and propose a drastic remedy
AMERICAN congressmen are used to hyperbole, but they were left speechless by the dire scenario Ben Bernanke, the chairman of the Federal Reserve, painted for them on the night of September 18th. He “told us that our American economy’s arteries, our financial system, is clogged, and if we don’t act, the patient will surely suffer a heart attack, maybe next week, maybe in six months, but it will happen,” according to Charles Schumer, a Democratic senator from New York. Mr Schumer’s interpretation: failure to act would cause “a depression”.
Mr Bernanke and Hank Paulson, the treasury secretary, had met congressional leaders to argue that ad hoc responses to the continuing financial crisis like that week’s bail-out of American International Group (AIG), a huge insurer, were no longer sufficient. By the weekend Mr Paulson had asked for authority to own up to $700 billion in mortgage-related assets. By the time The Economist went to press, Congress and Mr Paulson appeared to have agreed on the broad outlines of what is being called the Troubled Asset Relief Programme, or TARP.
The doctors' bill
Sep 25th 2008 WASHINGTON, DC
From The Economist print edition
The chairman of the Federal Reserve and the treasury secretary give Congress a gloomy prognosis for the economy, and propose a drastic remedy
AMERICAN congressmen are used to hyperbole, but they were left speechless by the dire scenario Ben Bernanke, the chairman of the Federal Reserve, painted for them on the night of September 18th. He “told us that our American economy’s arteries, our financial system, is clogged, and if we don’t act, the patient will surely suffer a heart attack, maybe next week, maybe in six months, but it will happen,” according to Charles Schumer, a Democratic senator from New York. Mr Schumer’s interpretation: failure to act would cause “a depression”.
Mr Bernanke and Hank Paulson, the treasury secretary, had met congressional leaders to argue that ad hoc responses to the continuing financial crisis like that week’s bail-out of American International Group (AIG), a huge insurer, were no longer sufficient. By the weekend Mr Paulson had asked for authority to own up to $700 billion in mortgage-related assets. By the time The Economist went to press, Congress and Mr Paulson appeared to have agreed on the broad outlines of what is being called the Troubled Asset Relief Programme, or TARP.
excellent articles from Oct 2nd
Global banks
On life support
Oct 2nd 2008From The Economist print edition
Governments in America and Europe scramble to rescue a collapsing system
Foreign exchange
The buck swaps here
Oct 2nd 2008From The Economist print edition
Central banks ease the market’s pain
The candidates intervene
Sep 25th 2008 WASHINGTON, DC
From The Economist print edition
The battle to save the financial system has now become part of the presidential race
JOBS will be lost, homes will be foreclosed, America will stumble into a recession and the economy will not recover in a normal, healthy way. All this will happen, Ben Bernanke warned members of Congress, if they do not approve a $700 billion bail-out for the financial sector. Mr Bernanke, the chairman of the Federal Reserve, and Hank Paulson, the treasury secretary, spent this week trying to persuade lawmakers to stump up the cash. But they met angry resistance from both parties.
The plan (see article) is for the Treasury to spend up to $700 billion to buy up mortgage-related assets, with the aim of getting credit flowing again. Given the urgency of forestalling a financial meltdown, a rescue package of some sort is likely to emerge, but the details are unclear. Will the government simply mop up toxic securities, or will it buy equity in ailing institutions? Will Congress sign a cheque for $700 billion, or start with a smaller sum and see how it goes? With the election—for all of the House of Representatives and a third of the Senate, not just for the presidency—barely a month away, no one wants the blame for failing to prevent a deep recession. But no one wants to be accused of showering taxpayers’ cash on bankers in $5,000 suits, either.
On life support
Oct 2nd 2008From The Economist print edition
Governments in America and Europe scramble to rescue a collapsing system
Foreign exchange
The buck swaps here
Oct 2nd 2008From The Economist print edition
Central banks ease the market’s pain
The candidates intervene
Sep 25th 2008 WASHINGTON, DC
From The Economist print edition
The battle to save the financial system has now become part of the presidential race
JOBS will be lost, homes will be foreclosed, America will stumble into a recession and the economy will not recover in a normal, healthy way. All this will happen, Ben Bernanke warned members of Congress, if they do not approve a $700 billion bail-out for the financial sector. Mr Bernanke, the chairman of the Federal Reserve, and Hank Paulson, the treasury secretary, spent this week trying to persuade lawmakers to stump up the cash. But they met angry resistance from both parties.
The plan (see article) is for the Treasury to spend up to $700 billion to buy up mortgage-related assets, with the aim of getting credit flowing again. Given the urgency of forestalling a financial meltdown, a rescue package of some sort is likely to emerge, but the details are unclear. Will the government simply mop up toxic securities, or will it buy equity in ailing institutions? Will Congress sign a cheque for $700 billion, or start with a smaller sum and see how it goes? With the election—for all of the House of Representatives and a third of the Senate, not just for the presidency—barely a month away, no one wants the blame for failing to prevent a deep recession. But no one wants to be accused of showering taxpayers’ cash on bankers in $5,000 suits, either.
leader on crisis
The credit crunch
World on the edge
Oct 2nd 2008
From The Economist print edition
Whatever happens in Congress, the crisis is now global; that means governments must work together
AMERICA’S Congress is not used to being second-guessed. But as lawmakers wrestled in the Capitol, world stockmarkets have been giving real-time odds on the Bush administration’s $700 billion bail-out becoming law. After the plan’s thrashing by the House of Representatives on September 29th, spurred on by voters’ loathing of “casino capitalism”, investors panicked. Yet as The Economist went to press, they were optimistic that, after winning the Senate’s approval on October 1st, the plan would pass.
Even if it does, that should not be a cause for optimism. Look beyond the stockmarkets, especially at the seized-up money markets, and there is little to see except bank failures, emergency rescues and high anxiety in the credit markets. These forces are drawing the financial system closer to disaster and the rich world to the edge of a nasty recession. The bail-out package should mitigate the problems, but it will not avert them.
The crisis is spreading in two directions—across the Atlantic to Europe, and out of the financial markets into the real economy. Governments have been dealing with it disaster by disaster. They have struggled to gain control not just because of the speed of contagion but also because policymakers, and the public they serve, have failed fully to grasp the breadth and depth of the crisis.
What’s the Icelandic for “domino”?
Step forward, Peer Steinbrück, Germany’s finance minister, who rashly declared on September 25th that America was “the source…and the focus of the crisis”, before heralding the end of its role as the financial superpower. Within days, the focus shifted and Mr Steinbrück and his officials were obliged to arrange a €35 billion ($51 billion) loan from German banks and the German government to save Hypo Real Estate, the country’s second-biggest property lender.
The hapless Mr Steinbrück is not alone. European banks were collapsing at a dizzying pace even as Christian Noyer, governor of the Bank of France, declared that “there is no drama in front of us.” Hypo Real Estate was just one of five banks in seven European countries bailed out in three days. Belgium, Luxembourg and the Netherlands carved up Fortis, a big bancassurer; Britain nationalised Bradford & Bingley; Belgium, France and Luxembourg saved Dexia; and Iceland rescued Glitnir. Separately, Ireland took €400 billion of contingent liabilities onto the national balance sheet, when it stood behind the deposits and debts of its six large banks and building societies. You have to wonder what Mr Noyer regards as dramatic.
By some measures, many European banks look more vulnerable than their American counterparts do—and that is saying quite something, given the past week’s forced sale of Washington Mutual, America’s biggest thrift, and Wachovia, its fourth-biggest commercial bank. In America, outside Wall Street, the banks have lent 96 cents for each $1 of deposits. Continental European banks have lent roughly €1.40 for each €1 of deposits. They have to borrow the rest from money-market investors, who are not especially confident just now. Some Europeans, including the British, Irish and Spanish banks, have housing busts of their own. And they must contend with the toxic American securities they bought by the billion, as well as their own slowing economies.
Western Europe is not the limit of this: the panic has also struck banks in Hong Kong, Russia and now India. And it is not just the geographical breadth of this crisis that is alarming, but also its economic depth. Because it is rooted in the money markets, it will feed through to businesses and households in every economy it hits.
Take a deep breath
Most of the time nobody notices the credit flowing through the lungs of the economy, any more than people notice the air they breathe. But everyone knows when credit stops circulating freely through markets to banks, businesses and consumers. For almost a year the markets had worried about banks’ liquidity and solvency. After the bankruptcy of Lehman Brothers last month, amid confusion about whom the state would save and on what terms, they panicked. The markets for three-, six- and 12-month paper are shut, so banks must borrow even more money overnight than usual.
Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers and other manufacturers will no longer extend credit and loans will become elusive and expensive. Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession.
Financial markets need governments to set rules for them; and when markets fail, governments are often best placed to get them going again. That’s pragmatism, not socialism. Helping bankers is not an end in itself. If the government could save the credit markets without bailing out the bankers, it should do so. But it cannot. Main Street needs Wall Street; and both need Washington. Politicians—and President George Bush is the most culpable among them —have failed to explain this.
Governments need not just to communicate, but also to co-ordinate. Past banking crises show that late, piecemeal rescues cost more and work less well. Ad hoc mergers work for a while, but demands for help tend to recur. Inconsistency sows uncertainty. Cross-border banking can make one country’s policies awkward for the neighbours: the Irish government’s guarantee of all deposits threatens to suck in money from poorly protected British banks. France’s suggestion on October 1st that Europe’s governments should work together was a good one; Germany’s rejection of it was wrong.
Central banks have co-ordinated their liquidity operations. Now that oil prices have plunged and worries about inflation are receding, interest-rate cuts are possible. They would be more powerful if co-ordinated. But it is not only central banks that need to combine. Whatever America’s Congress does, governments should work together on principles to stabilise and recapitalise banks—not just to stem panic but also to save money. Even if, as the Europeans claim, the crisis was made in America, it now belongs to everyone.
World on the edge
Oct 2nd 2008
From The Economist print edition
Whatever happens in Congress, the crisis is now global; that means governments must work together
AMERICA’S Congress is not used to being second-guessed. But as lawmakers wrestled in the Capitol, world stockmarkets have been giving real-time odds on the Bush administration’s $700 billion bail-out becoming law. After the plan’s thrashing by the House of Representatives on September 29th, spurred on by voters’ loathing of “casino capitalism”, investors panicked. Yet as The Economist went to press, they were optimistic that, after winning the Senate’s approval on October 1st, the plan would pass.
Even if it does, that should not be a cause for optimism. Look beyond the stockmarkets, especially at the seized-up money markets, and there is little to see except bank failures, emergency rescues and high anxiety in the credit markets. These forces are drawing the financial system closer to disaster and the rich world to the edge of a nasty recession. The bail-out package should mitigate the problems, but it will not avert them.
The crisis is spreading in two directions—across the Atlantic to Europe, and out of the financial markets into the real economy. Governments have been dealing with it disaster by disaster. They have struggled to gain control not just because of the speed of contagion but also because policymakers, and the public they serve, have failed fully to grasp the breadth and depth of the crisis.
What’s the Icelandic for “domino”?
Step forward, Peer Steinbrück, Germany’s finance minister, who rashly declared on September 25th that America was “the source…and the focus of the crisis”, before heralding the end of its role as the financial superpower. Within days, the focus shifted and Mr Steinbrück and his officials were obliged to arrange a €35 billion ($51 billion) loan from German banks and the German government to save Hypo Real Estate, the country’s second-biggest property lender.
The hapless Mr Steinbrück is not alone. European banks were collapsing at a dizzying pace even as Christian Noyer, governor of the Bank of France, declared that “there is no drama in front of us.” Hypo Real Estate was just one of five banks in seven European countries bailed out in three days. Belgium, Luxembourg and the Netherlands carved up Fortis, a big bancassurer; Britain nationalised Bradford & Bingley; Belgium, France and Luxembourg saved Dexia; and Iceland rescued Glitnir. Separately, Ireland took €400 billion of contingent liabilities onto the national balance sheet, when it stood behind the deposits and debts of its six large banks and building societies. You have to wonder what Mr Noyer regards as dramatic.
By some measures, many European banks look more vulnerable than their American counterparts do—and that is saying quite something, given the past week’s forced sale of Washington Mutual, America’s biggest thrift, and Wachovia, its fourth-biggest commercial bank. In America, outside Wall Street, the banks have lent 96 cents for each $1 of deposits. Continental European banks have lent roughly €1.40 for each €1 of deposits. They have to borrow the rest from money-market investors, who are not especially confident just now. Some Europeans, including the British, Irish and Spanish banks, have housing busts of their own. And they must contend with the toxic American securities they bought by the billion, as well as their own slowing economies.
Western Europe is not the limit of this: the panic has also struck banks in Hong Kong, Russia and now India. And it is not just the geographical breadth of this crisis that is alarming, but also its economic depth. Because it is rooted in the money markets, it will feed through to businesses and households in every economy it hits.
Take a deep breath
Most of the time nobody notices the credit flowing through the lungs of the economy, any more than people notice the air they breathe. But everyone knows when credit stops circulating freely through markets to banks, businesses and consumers. For almost a year the markets had worried about banks’ liquidity and solvency. After the bankruptcy of Lehman Brothers last month, amid confusion about whom the state would save and on what terms, they panicked. The markets for three-, six- and 12-month paper are shut, so banks must borrow even more money overnight than usual.
Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers and other manufacturers will no longer extend credit and loans will become elusive and expensive. Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession.
Financial markets need governments to set rules for them; and when markets fail, governments are often best placed to get them going again. That’s pragmatism, not socialism. Helping bankers is not an end in itself. If the government could save the credit markets without bailing out the bankers, it should do so. But it cannot. Main Street needs Wall Street; and both need Washington. Politicians—and President George Bush is the most culpable among them —have failed to explain this.
Governments need not just to communicate, but also to co-ordinate. Past banking crises show that late, piecemeal rescues cost more and work less well. Ad hoc mergers work for a while, but demands for help tend to recur. Inconsistency sows uncertainty. Cross-border banking can make one country’s policies awkward for the neighbours: the Irish government’s guarantee of all deposits threatens to suck in money from poorly protected British banks. France’s suggestion on October 1st that Europe’s governments should work together was a good one; Germany’s rejection of it was wrong.
Central banks have co-ordinated their liquidity operations. Now that oil prices have plunged and worries about inflation are receding, interest-rate cuts are possible. They would be more powerful if co-ordinated. But it is not only central banks that need to combine. Whatever America’s Congress does, governments should work together on principles to stabilise and recapitalise banks—not just to stem panic but also to save money. Even if, as the Europeans claim, the crisis was made in America, it now belongs to everyone.
Banks & borrowing
Blocked Pipes
Oct 2nd 2008 LONDON AND NEW YORK
From The Economist print edition
When banks find it hard to borrow, so do the rest of us
ANY good tradesman will tell you the importance of the bits of a house that you cannot see. Never mind the new kitchen: what about the rafters, the wiring and the pipes? So it is with financial markets. The stockmarkets are the most visible: as they soar or swoon, the headline-writers get to work. The money markets, however, are the plumbing of the system. Normally, they function efficiently and unseen, allowing investment institutions, companies and banks to lend and borrow trillions of dollars for up to a year at a time. They are only noticed when they go wrong. And, like plumbing, when they do get blocked, they make an almighty stink.
At the moment, these markets are well and truly bunged up. In the words of Michael Hartnett, a strategist at Merrill Lynch, “the global interbank market is effectively closed.” The equivalent of a run on banks has been taking place, without the queues of depositors seen outside Northern Rock, a British mortgage bank, last year. This stealthy run has been led by institutional investors and by banks themselves.
Many banks have had to be rescued by rivals or the state. This week the Irish government felt compelled to guarantee the deposits and some other liabilities of the country’s six largest banks. Surviving banks have become ultra-cautious—“just taking things one day at a time,” says Matt King, a strategist at Citigroup.
The effect has been most dramatic in the overnight rate for borrowing dollars. Bank borrowing costs reached 6.88% on September 30th, more than three times the level of official American rates, while some were willing to pay a remarkable 11% to borrow dollars from the European Central Bank (ECB). Banks have become so risk-averse that they deposited a record €44 billion ($62 billion) with the ECB on September 30th even though they could have earned more than two extra percentage points by lending to other banks. It was the last day of the quarter and, for balance-sheet reasons, banks were particularly keen to have cash on hand. (Overnight rates fell back on October 1st, but one-month rates rose further, indicating that the crisis had not eased.)
In the absence of private-sector lenders to banks, central banks have become vital suppliers in the money markets. With the help of the ECB, the Bank of England and the Bank of Japan, the Federal Reserve agreed to lend a further $620 billion on September 29th (see article). That package, though of similar size to the Bush administration’s $700 billion bail-out plan, did not need congressional approval or attract public opposition.
But central banks can only do so much. In particular, they tend to lend for short periods and then only against collateral with a high credit rating. That still leaves banks with the problem of financing their more troubled assets, an issue the Bush administration’s plan was designed to solve.
The money markets’ difficulties began in July 2007, when two Bear Stearns hedge funds revealed the damage done to their portfolios by subprime mortgages. Since August of that year, central banks have been intervening to keep them functioning, with a series of schemes like America’s Term Auction Facility. But the collapse of Lehman Brothers, followed by the long series of rescues in Europe and America, seems to have brought the money markets close to breakdown. Even immediate passage of the Bush plan would not solve all their problems straight away, because it would take time to put the plan into place.
Why do these markets matter? First, the rates on loans paid by many consumers (adjustable-rate mortgages, for example) and companies are set with reference to the money markets. Higher rates for banks mean higher rates for everyone. Second, if the markets are blocked for more than a week some companies may find it hard to get any finance at any price. That could mean more bankruptcies and job losses. Third, more banks could go bust if the blockage continues, making investors even more risk-averse. The downward spiral would take another turn.
“We are at the juncture where more widespread and permanent support is required to restore confidence in the banking sector,” say analysts at the Royal Bank of Scotland (RBS). “Without it, the banks will be aggressively trying to contract their books and will be unable to provide credit to retail and corporate clients.”
So it is safe to say that, until the money markets behave more normally, the financial crisis will not be over. And until the financial crisis is over, the global economy may not recover.
Liquid dynamite
First, the problem. It is widely assumed that central banks set the level of interest rates in their domestic markets. But the rate they announce is the one at which they will lend to the banking system. When banks borrow from anyone else (including other banks), they pay more. Every day, this rate is calculated through a poll of participating banks and published as Libor (London interbank offered rate) or Euribor (Euro interbank offered rate).
Normally, these are only a fraction of a percentage point above the official interest rates. But that has changed dramatically in recent weeks (see chart 1). Take the cost of borrowing dollars. On October 1st banks had to pay 4.15% for three-month money, more than two percentage points above the fed funds target rate. In theory, three-month rates could be that high because markets are expecting a sharp rise in official rates. But that is hardly likely, given the depth of the crisis.
Instead, the width of the margin reflects investors’ worries about the banks, not least because so many have faltered so quickly. Three months is now a long time to trust in the health of a bank. In addition, banks are anxious to conserve their own cash, in case depositors make large withdrawals or their money gets tied up in the collapse of another bank, as with Lehman.
One way this risk aversion shows up is in the “Ted spread” (see chart 2), the gap between three-month dollar Libor and the Treasury-bill rate. After being as low as 20 basis points (a fifth of a percentage point) in early 2007, the spread is now 3.3 percentage points. In other words, the relative cost of raising money for banks has risen 16-fold in the past 18 months.
Indeed, some banks argue that Libor and Euribor understate the full extent of the increase in banks’ borrowing costs. According to John Grout of the (British) Association of Corporate Treasurers (ACT), banks have started to talk to companies about invoking the “market disruption” clause in loan contracts. This would allow them to replace the two benchmarks with the “real” cost of their funds, which they say would be higher. (Companies usually pay Libor or Euribor plus a margin that depends on the riskiness of their finances.) One company, Hon Hai of Taiwan, an electronics manufacturer, says its banks have already invoked the clause.
This affects only debt facilities that have already been set up. Mr Grout says that when companies are negotiating new loans with banks, they are being asked to accept rates based on Libor plus a quarter of a percentage point. Unsurprisingly, the ACT is unimpressed with this tactic, since Libor is calculated from data supplied by the banks themselves.
Companies do not have to borrow from banks; they can raise money from the markets by selling commercial paper, a type of short-term debt. For much of this year, that was an attractive option. The preference of investors for debt issued by non-financial companies made commercial paper a source of cheap finance.
But in recent weeks even this has become more difficult. The volume of commercial paper outstanding fell by $61 billion to $1.7 trillion in the week ending September 24th. And investors are unwilling to lend for long: AT&T, a big American telecoms company, said on September 30th that the previous week it had been unable to sell any commercial paper with a maturity longer than overnight. The volume of asset-backed commercial paper maturing in four days or less ballooned from $32 billion a day to $104 billion during September (see chart 3), while the amount maturing in 21 to 40 days fell by 63%.
Where there is doubt about a company’s finances, it inevitably has to pay a higher rate. Worries about GE, one of America’s most prestigious companies, pushed up the premium on its credit-default swaps and made raising short-term debt dearer. According to the Wall Street Journal, the rate on its commercial paper had gone up by two-fifths of a percentage point. That might not sound much, but GE has $90 billion of paper outstanding, so it faced an extra interest bill of $360m a year. On October 1st the company announced a $12 billion public share offering and a $3 billion injection from Warren Buffett, a leading investor.
Why has commercial paper lost its shine? The explanation seems to lie back in the authorities’ willingness to allow Lehman to collapse. That move, designed to warn the markets that the authorities took moral hazard seriously, has had some unintended consequences.
Fund of surprises
The most severe was the loss imposed on the Reserve Primary fund, a money-market fund. Such funds invest in short-term debt and offer investors higher rates than on bank deposits. But they also aim to repay their customers at par. Because it had bought Lehman debt, the Reserve Primary fund was forced to “break the buck” (that is, to repay less than 100 cents on the dollar), only the second such instance in the industry’s history. This caused a crisis of confidence in money-market funds. “Prime” funds, which offer slightly above-average rates in return for higher risk, have lost about $400 billion out of $1.3 trillion in the past few weeks, as investors have switched to funds based on government debt. In turn that has made other funds more cautious and led them to steer clear of bank loans and commercial paper.
Illustration by David Simonds
At the same time as they are struggling to raise money from outsiders, banks may face more claims on their capital. In the good times they promised to provide back-up loans to companies—which they thought would never be asked for. On some estimates, the value of these promises is $6 trillion. But with the commercial-paper market tightening and the economy deteriorating, more companies will be asking banks to keep their word.
Indeed, companies already seem concerned that banks will be unable to maintain promised loan facilities. So they are using those credit lines earlier than expected, in case they vanish. A prime example is Duke Energy, an American utility, which recently drew down $1 billion from a credit agreement. Chris Taggert of CreditSights, a research group, foresees a “funding blitzkrieg” by high-yield borrowers tapping their banks for cash if the mayhem does not abate.
“There’s a vicious-spiral element to the inability of companies to roll commercial paper,” says Ajay Rajadhyaksha, a fixed-income strategist at Barclays Capital. “Those that have back-up lines of credit with banks are increasingly drawing on them. This is hurting the banks, and making money-market funds even queasier about buying bank debt, and so on.”
CreditSights notes that it has become more common for companies to call on these loans amid “fears that bank lenders may not be able to honour commitments in the future.” Several of these companies, including General Motors, have cited the uncertain state of capital markets when asking for their money. Goodyear Tire & Rubber said it was drawing down its loans because some of its cash was locked up in, of all places, the Reserve Primary money-market fund.
Whatever the reason, the possibility of more calls from their corporate clients is another factor behind the banks’ desire to hold cash. That will mean any company without a back-up facility may struggle to raise new loans.
Luckily, most companies are not as exposed as they were when the dotcom bubble burst. Nevertheless, plenty of carmakers and retailers have mountains of debt or a strong need for cash. Then there are companies that underwent leveraged buy-outs. The private-equity groups that bought them may have been counting on refinancing their debts soon.
A lack of access to capital is sure to make companies cautious. “Your ability to plan for investment is obviously affected,” says Randall Stephenson, chairman and chief executive of AT&T. In addition, higher finance costs will eat into profit growth, a fact that seems yet to be recognised in buoyant forecasts for 2009. “The equity market is going through the slow process of realisation that a large proportion of earnings growth over the last 25 years was due to the falling cost of money,” says Kit Juckes, an economist at RBS.
Polonius’s revenge
Consumers have been going on a greater debt binge than companies and the impact on them may be more immediate. In particular, they may face higher mortgage and credit-card rates. Some may be denied new credit altogether.
The last survey of senior loan officers by the Federal Reserve was back in July. Even then 65% of banks were tightening their lending standards on credit cards, up from 30% in April. Consumers had not felt the effects by then: credit-card lending rose by 4.75% in the year to July, although other types of credit barely grew at all.
Mortgage costs have also been rising for those with variable-rate loans. On September 30th, American adjustable-rate mortgage rates were 6.13%, according to Bloomberg, compared with 5.92% at the end of August and less than 5.5% in the spring. In Britain three leading lenders raised rates by half a percentage point in the week to September 26th. And Moneyfacts, an information group, says the number of buy-to-let mortgages (used by private landlords) has fallen 85% over the last year.
These effects might teach voters that punishing the banks for their follies is sometimes cutting off their noses to spite their faces. “At some point Main Street will realise it lies on the same road as Wall Street,” says Mr Juckes.
It is not too difficult to imagine bank failures leading to job losses, further falls in house prices, bad consumer debts and further bank losses. “We may already be at the point where corporate fear and conservatism are baked in: even if things start to improve for the banks, companies have seen how bad things can get, and that can prove lasting,” says Torsten Slok, an economist at Deutsche Bank. “So there is a risk they’ll continue to hoard cash and mistrust banks for quite some time.” That is the kind of spiral which the Bush administration’s plan was designed to avoid.
Relying solely on ad hoc rescues of individual banks would only make investors more nervous about the banks that remain. The financial plumbing would stay bunged up. Unless something is done to unblock it soon, there will not just be a nasty stink in the markets. There will also be an unholy mess in the wider economy.
Oct 2nd 2008 LONDON AND NEW YORK
From The Economist print edition
When banks find it hard to borrow, so do the rest of us
ANY good tradesman will tell you the importance of the bits of a house that you cannot see. Never mind the new kitchen: what about the rafters, the wiring and the pipes? So it is with financial markets. The stockmarkets are the most visible: as they soar or swoon, the headline-writers get to work. The money markets, however, are the plumbing of the system. Normally, they function efficiently and unseen, allowing investment institutions, companies and banks to lend and borrow trillions of dollars for up to a year at a time. They are only noticed when they go wrong. And, like plumbing, when they do get blocked, they make an almighty stink.
At the moment, these markets are well and truly bunged up. In the words of Michael Hartnett, a strategist at Merrill Lynch, “the global interbank market is effectively closed.” The equivalent of a run on banks has been taking place, without the queues of depositors seen outside Northern Rock, a British mortgage bank, last year. This stealthy run has been led by institutional investors and by banks themselves.
Many banks have had to be rescued by rivals or the state. This week the Irish government felt compelled to guarantee the deposits and some other liabilities of the country’s six largest banks. Surviving banks have become ultra-cautious—“just taking things one day at a time,” says Matt King, a strategist at Citigroup.
The effect has been most dramatic in the overnight rate for borrowing dollars. Bank borrowing costs reached 6.88% on September 30th, more than three times the level of official American rates, while some were willing to pay a remarkable 11% to borrow dollars from the European Central Bank (ECB). Banks have become so risk-averse that they deposited a record €44 billion ($62 billion) with the ECB on September 30th even though they could have earned more than two extra percentage points by lending to other banks. It was the last day of the quarter and, for balance-sheet reasons, banks were particularly keen to have cash on hand. (Overnight rates fell back on October 1st, but one-month rates rose further, indicating that the crisis had not eased.)
In the absence of private-sector lenders to banks, central banks have become vital suppliers in the money markets. With the help of the ECB, the Bank of England and the Bank of Japan, the Federal Reserve agreed to lend a further $620 billion on September 29th (see article). That package, though of similar size to the Bush administration’s $700 billion bail-out plan, did not need congressional approval or attract public opposition.
But central banks can only do so much. In particular, they tend to lend for short periods and then only against collateral with a high credit rating. That still leaves banks with the problem of financing their more troubled assets, an issue the Bush administration’s plan was designed to solve.
The money markets’ difficulties began in July 2007, when two Bear Stearns hedge funds revealed the damage done to their portfolios by subprime mortgages. Since August of that year, central banks have been intervening to keep them functioning, with a series of schemes like America’s Term Auction Facility. But the collapse of Lehman Brothers, followed by the long series of rescues in Europe and America, seems to have brought the money markets close to breakdown. Even immediate passage of the Bush plan would not solve all their problems straight away, because it would take time to put the plan into place.
Why do these markets matter? First, the rates on loans paid by many consumers (adjustable-rate mortgages, for example) and companies are set with reference to the money markets. Higher rates for banks mean higher rates for everyone. Second, if the markets are blocked for more than a week some companies may find it hard to get any finance at any price. That could mean more bankruptcies and job losses. Third, more banks could go bust if the blockage continues, making investors even more risk-averse. The downward spiral would take another turn.
“We are at the juncture where more widespread and permanent support is required to restore confidence in the banking sector,” say analysts at the Royal Bank of Scotland (RBS). “Without it, the banks will be aggressively trying to contract their books and will be unable to provide credit to retail and corporate clients.”
So it is safe to say that, until the money markets behave more normally, the financial crisis will not be over. And until the financial crisis is over, the global economy may not recover.
Liquid dynamite
First, the problem. It is widely assumed that central banks set the level of interest rates in their domestic markets. But the rate they announce is the one at which they will lend to the banking system. When banks borrow from anyone else (including other banks), they pay more. Every day, this rate is calculated through a poll of participating banks and published as Libor (London interbank offered rate) or Euribor (Euro interbank offered rate).
Normally, these are only a fraction of a percentage point above the official interest rates. But that has changed dramatically in recent weeks (see chart 1). Take the cost of borrowing dollars. On October 1st banks had to pay 4.15% for three-month money, more than two percentage points above the fed funds target rate. In theory, three-month rates could be that high because markets are expecting a sharp rise in official rates. But that is hardly likely, given the depth of the crisis.
Instead, the width of the margin reflects investors’ worries about the banks, not least because so many have faltered so quickly. Three months is now a long time to trust in the health of a bank. In addition, banks are anxious to conserve their own cash, in case depositors make large withdrawals or their money gets tied up in the collapse of another bank, as with Lehman.
One way this risk aversion shows up is in the “Ted spread” (see chart 2), the gap between three-month dollar Libor and the Treasury-bill rate. After being as low as 20 basis points (a fifth of a percentage point) in early 2007, the spread is now 3.3 percentage points. In other words, the relative cost of raising money for banks has risen 16-fold in the past 18 months.
Indeed, some banks argue that Libor and Euribor understate the full extent of the increase in banks’ borrowing costs. According to John Grout of the (British) Association of Corporate Treasurers (ACT), banks have started to talk to companies about invoking the “market disruption” clause in loan contracts. This would allow them to replace the two benchmarks with the “real” cost of their funds, which they say would be higher. (Companies usually pay Libor or Euribor plus a margin that depends on the riskiness of their finances.) One company, Hon Hai of Taiwan, an electronics manufacturer, says its banks have already invoked the clause.
This affects only debt facilities that have already been set up. Mr Grout says that when companies are negotiating new loans with banks, they are being asked to accept rates based on Libor plus a quarter of a percentage point. Unsurprisingly, the ACT is unimpressed with this tactic, since Libor is calculated from data supplied by the banks themselves.
Companies do not have to borrow from banks; they can raise money from the markets by selling commercial paper, a type of short-term debt. For much of this year, that was an attractive option. The preference of investors for debt issued by non-financial companies made commercial paper a source of cheap finance.
But in recent weeks even this has become more difficult. The volume of commercial paper outstanding fell by $61 billion to $1.7 trillion in the week ending September 24th. And investors are unwilling to lend for long: AT&T, a big American telecoms company, said on September 30th that the previous week it had been unable to sell any commercial paper with a maturity longer than overnight. The volume of asset-backed commercial paper maturing in four days or less ballooned from $32 billion a day to $104 billion during September (see chart 3), while the amount maturing in 21 to 40 days fell by 63%.
Where there is doubt about a company’s finances, it inevitably has to pay a higher rate. Worries about GE, one of America’s most prestigious companies, pushed up the premium on its credit-default swaps and made raising short-term debt dearer. According to the Wall Street Journal, the rate on its commercial paper had gone up by two-fifths of a percentage point. That might not sound much, but GE has $90 billion of paper outstanding, so it faced an extra interest bill of $360m a year. On October 1st the company announced a $12 billion public share offering and a $3 billion injection from Warren Buffett, a leading investor.
Why has commercial paper lost its shine? The explanation seems to lie back in the authorities’ willingness to allow Lehman to collapse. That move, designed to warn the markets that the authorities took moral hazard seriously, has had some unintended consequences.
Fund of surprises
The most severe was the loss imposed on the Reserve Primary fund, a money-market fund. Such funds invest in short-term debt and offer investors higher rates than on bank deposits. But they also aim to repay their customers at par. Because it had bought Lehman debt, the Reserve Primary fund was forced to “break the buck” (that is, to repay less than 100 cents on the dollar), only the second such instance in the industry’s history. This caused a crisis of confidence in money-market funds. “Prime” funds, which offer slightly above-average rates in return for higher risk, have lost about $400 billion out of $1.3 trillion in the past few weeks, as investors have switched to funds based on government debt. In turn that has made other funds more cautious and led them to steer clear of bank loans and commercial paper.
Illustration by David Simonds
At the same time as they are struggling to raise money from outsiders, banks may face more claims on their capital. In the good times they promised to provide back-up loans to companies—which they thought would never be asked for. On some estimates, the value of these promises is $6 trillion. But with the commercial-paper market tightening and the economy deteriorating, more companies will be asking banks to keep their word.
Indeed, companies already seem concerned that banks will be unable to maintain promised loan facilities. So they are using those credit lines earlier than expected, in case they vanish. A prime example is Duke Energy, an American utility, which recently drew down $1 billion from a credit agreement. Chris Taggert of CreditSights, a research group, foresees a “funding blitzkrieg” by high-yield borrowers tapping their banks for cash if the mayhem does not abate.
“There’s a vicious-spiral element to the inability of companies to roll commercial paper,” says Ajay Rajadhyaksha, a fixed-income strategist at Barclays Capital. “Those that have back-up lines of credit with banks are increasingly drawing on them. This is hurting the banks, and making money-market funds even queasier about buying bank debt, and so on.”
CreditSights notes that it has become more common for companies to call on these loans amid “fears that bank lenders may not be able to honour commitments in the future.” Several of these companies, including General Motors, have cited the uncertain state of capital markets when asking for their money. Goodyear Tire & Rubber said it was drawing down its loans because some of its cash was locked up in, of all places, the Reserve Primary money-market fund.
Whatever the reason, the possibility of more calls from their corporate clients is another factor behind the banks’ desire to hold cash. That will mean any company without a back-up facility may struggle to raise new loans.
Luckily, most companies are not as exposed as they were when the dotcom bubble burst. Nevertheless, plenty of carmakers and retailers have mountains of debt or a strong need for cash. Then there are companies that underwent leveraged buy-outs. The private-equity groups that bought them may have been counting on refinancing their debts soon.
A lack of access to capital is sure to make companies cautious. “Your ability to plan for investment is obviously affected,” says Randall Stephenson, chairman and chief executive of AT&T. In addition, higher finance costs will eat into profit growth, a fact that seems yet to be recognised in buoyant forecasts for 2009. “The equity market is going through the slow process of realisation that a large proportion of earnings growth over the last 25 years was due to the falling cost of money,” says Kit Juckes, an economist at RBS.
Polonius’s revenge
Consumers have been going on a greater debt binge than companies and the impact on them may be more immediate. In particular, they may face higher mortgage and credit-card rates. Some may be denied new credit altogether.
The last survey of senior loan officers by the Federal Reserve was back in July. Even then 65% of banks were tightening their lending standards on credit cards, up from 30% in April. Consumers had not felt the effects by then: credit-card lending rose by 4.75% in the year to July, although other types of credit barely grew at all.
Mortgage costs have also been rising for those with variable-rate loans. On September 30th, American adjustable-rate mortgage rates were 6.13%, according to Bloomberg, compared with 5.92% at the end of August and less than 5.5% in the spring. In Britain three leading lenders raised rates by half a percentage point in the week to September 26th. And Moneyfacts, an information group, says the number of buy-to-let mortgages (used by private landlords) has fallen 85% over the last year.
These effects might teach voters that punishing the banks for their follies is sometimes cutting off their noses to spite their faces. “At some point Main Street will realise it lies on the same road as Wall Street,” says Mr Juckes.
It is not too difficult to imagine bank failures leading to job losses, further falls in house prices, bad consumer debts and further bank losses. “We may already be at the point where corporate fear and conservatism are baked in: even if things start to improve for the banks, companies have seen how bad things can get, and that can prove lasting,” says Torsten Slok, an economist at Deutsche Bank. “So there is a risk they’ll continue to hoard cash and mistrust banks for quite some time.” That is the kind of spiral which the Bush administration’s plan was designed to avoid.
Relying solely on ad hoc rescues of individual banks would only make investors more nervous about the banks that remain. The financial plumbing would stay bunged up. Unless something is done to unblock it soon, there will not just be a nasty stink in the markets. There will also be an unholy mess in the wider economy.
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