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Credit Crunched: The Bank of England View


You can find a good discussion of what’s being going on in the Bank of England’s latest Financial Stability Report (hot off the presses today!). Note, in particular, this (from page 19):

The second phase of the turmoil involved rapidly rising stress across funding and other financial markets. The failure of Lehman Brothers caused a steep increase in market stress internationally as counterparties took steps to limit their exposures to the company and to other financial institutions. Lending maturities in the interbank market were shortened,with many banks and other institutions only able to borrow overnight. Three-month Libor spreads over official rates hit new highs. Money withdrawn from the market was reinvested in assets perceived to be a safe haven, such as gold and government debt. US Treasury bill yields fell towards,and briefly below, zero, reaching levels last seen during the Second World War.

The role of money market mutual funds (MMMFs) in contracting the supply of credit to banks was particularly significant.(1) Many investors withdrew money from US dollar MMMFs after some funds made losses on holdings of Lehman Brothers’ commercial paper (CP). Around 5% of assets under management were withdrawn in the second half of September alone. In addition, many clients switched investments from so-called ‘prime’ funds that invest in private sector debt, including CP, to funds that invest in government debt. That forced MMMFs to reduce their own investments in CP, contributing to a US$74 billion (or 4.2%) fall in the total amount of dollar-denominated CP outstanding during the first week following the failure of Lehman Brothers, and a shortening in the maturity of new issuance.


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