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Where will the $700-billion (U.S.) in the Wall Street
bailout package go and how will prices be determined?
The money will be paid to Wall Street firms, banks, pension funds and other companies
that hold bad mortgages and other toxic assets. The values aren't known at this
point, and the amount paid will be decided in a reverse auction, in which the sellers
of the assets compete with each other and decide how cheaply they will sell the
toxic debts. The government, through the newly appointed Office of Financial Stability,
then pays the lowest price offered.
Will the money ever be recovered?
The U.S. Treasury Department has said there is a good chance it will recover some
if not all of the money, although observers are not so certain. Previous rescue
efforts have actually turned a profit, although others have cost billions.
Who wins and who loses?
While it's theoretical at this point, financial institutions could win out by having
their toxic assets bought by the government at what is effectively a premium. While
banks can dispose of some of these assets now, they would be doing so at firesale
prices if buyers are found. In an ideal world, the U.S. government would hold on
to the troubled assets until maturity, when hopefully the real estate market will
have recovered, and then dispose of them at at least breakeven. But it is a long-term
process, and thus it is too early to tell how the taxpayer makes out.
Why have central banks been unable to halt the credit crisis?
The Bank of Canada continued its efforts to add some grease to the financial system,
but there was no sign of any change for the better. In the United States, pressure
has been building on the Federal Reserve to push through an emergency interest rate
cut to bolster confidence. There has been talk that other countries would similarly
cut rates.
Why aren't banks lending to each other?
Banks normally lend each other cash and short-term securities to help balance out
their everyday activities. But lately, banks around the world have been extraordinarily
cautious about this lending - partly because they are worried about getting repaid
- and this is driving up the interest rate they have to pay when they want to borrow.
This also makes the banks much more cautious about lending out the money that they
receive in deposits, thus making it more difficult - and more expensive - for homeowners,
small businesses or corporations to borrow.
The standard interest rate for interbank loans is Libor, an acronym for the London
interbank offered rate. Libor is an average of interbank rates offered by more than
a dozen banks, and is calculated every day. The difference between Libor and government
bond yields has been growing recently, and that's important because corporate loans,
mortgages and student loans are all based on Libor.
Don't banks usually get the money they lend from deposits?
That is usually the case, but the balance is never perfect, and that's why banks
lend money to each other. Currently, there is a lot of demand for loans from corporations,
which until recently haven't needed much money because they've been so profitable.
What is a liquidity injection?
Central banks can use their financial clout to try to get money flowing to the commercial
banks and their customers. In a liquidity injection, they make money available for
banks to borrow, although the financial institutions have to post securities as
collateral to get it. Last week the Bank of Canada said it would make $20-billion
available to Canadian banks, and yesterday it said it would let banks pledge their
troubled asset-backed commercial paper assets as collateral. This will give some
banks - at least those with large pools of ABCP - more flexibility.
One problem, said TD Bank chief economist Don Drummond, is that the central bank's
liquidity injection is just for the short term - Bank of Canada loans usually have
to be repaid within 90 days. But the demand from customers is trending toward longer-term
loans - especially from corporations that can't get money any other way - so the
central bank money won't help much on that score.
Where do the central banks get the money for a liquidity injection?
The Bank of Canada has billions of dollars in assets - about $56-billion, at last
count - mostly held in very safe securities such as bonds and treasury bills. In
essence, when it makes money available to commercial banks, it is temporarily swapping
its safe securities for the riskier ones the banks are putting up as collateral.
Are my bank deposits safe?
Bank deposits in this country - GICs or other deposits that mature in five years
or less - are insured by the CDIC, a government agency. But the limit is $100,000
per person per institution and not all financial institutions are members.
Depending on the type of account in question, more than one account may be covered
to $100,000 at a given bank. In Europe, some countries have recently removed any
limits, to make sure that there is no rush of worried customers taking their money
out and stuffing it under their mattresses. In Canada there has been no move to
change the limit.
The CDIC points out on its website that banks in Canada don't fail often, but "it
has happened and it could happen again." In fact, 43 CDIC members - mostly
small ones - have collapsed since it was formed in 1967.
What is a credit default swap?
These were originally set up as a kind of insurance against bad debts. A holder
would pay a series of "premiums," and in return they would get a payout
if a specified organization failed. It's the same idea as paying a life insurance
premium, where the beneficiary gets a payout only if the specified person dies.
Like life insurance, everything is in balance unless there is an epidemic and people
start dying left and right. With more companies going under, or threatening to do
so, firms that issued swaps are themselves in trouble. That's what happened to insurer
AIG, which sold credit default swaps that protected investors against bond defaults.
When bonds started defaulting, AIG itself was left vulnerable.
What is counterparty risk?
When you lend $20 to a friend, the counterparty risk is the chance that he or she
won't pay you back. It works the same way with corporations or financial institutions,
although their measurement of risk is a little more sophisticated. If the counterparty
risk is high, traders and banks won't lend money unless they get some solid collateral
or loan guarantees, or they might just say "forget it."
Are any parts of the stock market doing okay right now?
Not really. It's more a matter of finding sectors that are less beaten up than others.
Consumer staples - think groceries and drugstores - is one. Telecom companies are
another. Financials, believe it or not, have also hung in comparatively well in
the recent market downturn after some big losses previously.
What should you do now?
Selling now means locking in potentially gut-wrenching losses that will ease when
the market turns around. One common feature of bear markets for stocks: They all
end and are replaced by bull markets. If you can stand the potential for more losses
in the near term, buying now will set up long-term gains in stocks.
Are there any safe places to invest right now?
The old cliché "cash is king" applies. Government Treasury Bills and short-term
bonds are safe, and so are guaranteed investment certificates and high-interest
savings accounts offered by banks, trust companies and credit unions that are members
of a deposit insurance scheme like the federally-backed Canada Deposit Insurance
Corp. (CDIC). Money market funds are not loss-proof, but they are an option if you're
looking for a place to park some money.
Tuesday, October 07, 2008
Richard Blackwell, Barrie McKenna and Rob Carrick
Report on Business