If you can keep your head when liquidity dries up

For the money markets liquidity is the problem says Martin O’Donovan.

The central banks have been working hard to supply liquidity into the inter-bank market and have just about been keeping the overnight rates near the official rates (Base Rate in the case of the UK), but the 3 month rates have stubbornly refused to follow suit and right now have ballooned out for sterling to 6.4% when base rate is just 5%.

Clearly the banks are keeping their cash very short term and 3 month liquidity has disappeared.

The credit crisis started with the financial community and has very much remained concentrated within financial circles. Inevitably this has spilled over to the wider economy, in particular hitting house builders and related consumer markets. But the riskiness of non financial companies is still perceived as far less than financial services companies, or at any rate there is less worry about undisclosed black holes.

For larger companies that have commercial paper programmes the flight to quality or rather the flight to any sector but banks has over the past year created a bonanza with great liquidity and the best ever rates in terms of margins. The money market funds have presumably had to invest somewhere and paper from non financial companies looked attractive.

But now, post Lehman, even the liquidity in the CP markets has dried up with availability shrinking right down to the overnight period. This reaction may just be the ultimate in playing it safe, but to me it looks irrational which means it should reverse fairly promptly.

If all else fails it is normal good practice for treasurers to have committed back up lines from their banks which are still available, albeit the pricing can exceed CP rates. So going full circle if corporate liquidity is not the issue why have the investors reined back? For the moment, this remains unanswered.

Committed credit facilities provide a contractual obligation for the banks to lend on request but if the banks are themselves suffering liquidity and cost of funds problems they may well be looking for excuses not to lend on these long standing facilities. Being risk averse creatures treasurers should be taking every precaution to make sure they are complying with every letter of the loan agreements, to make sure there are no excuses and let outs for the lenders.

 If you can keep your head when all about you / Are losing theirs ... Rudyard Kipling