Banks under fire in subprime crisis

By Morgan Hamon, FRANKFURT, AFP

By injecting billions into the money markets in the wake of fears about the U.S. housing market, central banks are reaping what they have sown after years of low interest rates, analysts said Tuesday. The European Central Bank, the Fed in the United States and Japan’s central bank have all pumped money into the markets over recent days in a sustained effort to give commercial banks the liquidity to continue making loans. But analysts said that low interest rates set by central banks in recent years had encouraged a credit boom and had sparked a rush towards high-risk areas such as the subprime home loans which are at the root of the problem,

“The record activity in leveraged buyouts and the low interest rates on risky loans are responsible for the crisis,” Joerg Kraemer, chief economist of Commerzbank, told AFP. “From this point of view, the ECB and the Fed have a direct responsibility because they kept interest rates at a very low levels in recent years,” he said. Ulrich Kater of Dekabank said: “With the low rates over the past few years the ECB prepared the ground for the crisis we are seeing today.” The Financial Times said the central banks were playing with fire when it came to “moral hazard”. In other words, their intervention might prompt investors to make risky decisions in the knowledge that they will not have to pay for their mistakes because the central banks will bail them out. The FT said in an editorial on Tuesday the ECB may well have got the balance wrong by pumping more than 200 billion euros into the market in recent days, but suggested it was trying to help steady, ‘good’ lenders and not the investment funds that threw money after the highly risk-prone subprime loans markets.

The ECB “may know something that justifies its aggressive generosity”, it said.

But it is not only central banks that have been busy.

Goldman Sachs, the U.S. investment banking giant, said Monday it had teamed up with other major investors to launch a US$3 billion (2.2 billion euro) bailout of a hedge fund it manages. Goldman said it was injecting the cash into its Global Equity Opportunities (GEO) fund after the turbulence on the markets had a sharply negative effect on the fund’s performance.

That followed the case of Germany’s IKB bank, which was forced to slash its full-year earnings forecast and replace its chief executive last month after the U.S. crisis led investors to pull money out of IKB-managed Rhineland Funding, which is exposed to shaky U.S. real estate loans. IKB’s main shareholder, the German state-owned KfW bank, came to the rescue by providing an 8.1 billion euro (US$11.1 billion) liquidity line.