On Friday, after president Donald Trump’s rose garden press conference with corporate chief executives to announce he was taking coronavirus seriously and declare it a national emergency, Bank of America’s share price shot up 17.8%.
Then, on Sunday, the Federal Reserve cut interest rates by 100 basis points, encouraged banks to use the discount window at an even further reduced cost and announced a $700 billion quantitative easing (QE) programme.
On Monday, Bank of America’s share price fell 15.3%.
These are not normal moves, but then these are not normal times.
The recession that is coming from the economic sudden stop to repress the coronavirus makes fundamental analysis of company values impossible. That’s not what these share price movements are about. They are about panic.
But they also show that this real economy shock, even though it did not start in the banking industry or in the financial markets, still threatens to overwhelm both.
A massive fiscal response from governments is now urgently required.
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Matt King, Citi |
Matt King, global head of credit products strategy at Citi, says this may “need to be on an unimaginably large scale”.
Banks, especially US banks, come into this with much higher levels of capital and of liquidity than when they drove into the financial crisis in 2008 and had to be bailed out by their governments.
Every banker Euromoney speaks to these days is an optimist clinging to one article of faith: that what we are seeing will certainly be desperate, but that it can be short-lived, maybe just a few months.
Time will tell if that is justified. Even if it is, how much damage will have been wrought by personal and business collapses that could set off a self-reinforcing spiral?
So, the question now is: can the banks deploy that capital and liquidity to support corporate customers and individuals through this sudden stop.
Commercial paper
The first signs in the week after the western world woke up to the emergency are alarming. Bank dealers appeared unwilling to intermediate between corporates that wish to issue commercial paper and money market funds that are trying to raise cash and shorten duration.
The Fed stepped in on Tuesday with a commercial paper funding facility (CPFF) to backstop corporate issuance, leveraging $10 billion in loss protection from the US Treasury.
Banks may appear to have good capital and liquidity ratios, but they still act as if they are balance-sheet constrained
By then issuers had already been drawing down their revolving credit lines from banks. Portfolio companies owned by private equity sponsors, who live on financial engineering, were particularly quick to draw on these. They are meant to be held in reserve for an emergency. This is an emergency.
Banks will have stress tested what happens when lots of borrowers draw at once. They know that it will stretch their capacity to lend to anyone else.
On Tuesday, the Fed announced a primary dealer credit facility that allows primary dealer banks of the New York Fed to borrow for up to 90 days against a broad array of collateral, including all types of investment grade bonds, commercial paper, mortgage-backed and asset-backed securities and even equities. The Fed says that additional forms of collateral may become acceptable in future.
Regulatory relief
But now calls are growing for a different kind of action from the Fed and other agencies: not financial relief but regulatory relief.
Bank chief executives have argued for some time that while regulators did well to force them to retain much higher levels of capital after the crisis, the thrust of some recent regulations has been highly pro-cyclical and likely to make banks cut back in a recession rather than lean in and support borrowers.
For example, banks stopped treating US Treasury bonds as equivalent to cash and stopped lending easily against them last year. And in recent weeks the repo market has once again shown strain while bid offer spreads widened even in on-the-run treasuries.
Banks may appear to have good capital and liquidity ratios, but they still act as if they are balance-sheet constrained, even with the Fed buying treasuries and supplying overnight cash in the repo markets.
Bank of America analysts report the growing behind-the-scenes calls for temporary regulatory relief, suggesting that, for example, regulators now carve out treasuries and cash from the supplementary leverage ratio, so that short-term borrowing against risk-free Treasury collateral is not deemed to have swollen bank balance sheets.
Such a move might allow dealers greater capacity to warehouse risk and so intermediate between investors in the Treasury market, which needs to function well as the underpinning for credit flows.
The analysts suggest conversations are already at least taking place over recalibrating some elements of the supplementary capital buffers imposed on US global systemically important banks.
If rules cannot be tweaked to allow banks freer use of their liquidity and capital reserves, the likely outcome is that, as well as being lender of last resort to the nation’s banks, the Fed also becomes the market-maker of last resort to its capital markets.
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