On the 18th the ECB held liquidity auctions taking the markets by surprise supplying as much as €348.6bn at 4.21 % for two weeks funding in an auction were 390 banks participated. Given the number of participating banks there are good chances that US and UK banks took part in that auction given the limitations they have to access those quantities in their national funding auctions. This very aggressive stance moved down the two-week euro London Interbank Offered Rate (LIBOR) a record 54 basis points to 4.4 per cent. A huge move! Moreover on Wednesday the ECB offered €50bn 3 months funding but banks demand came short of that amount. Same day the ECB mopped-up €133.6bn of overnight money in an effort to fine tune the excess of liquidity offered the prior day. The ECB also announced that the discount window was used on Monday in an amount of €2.44bn.
These weekly events revealed: First, there is true stress in the European market. This is shown not only on the use of the discount window on Monday but also on the amount of funds demanded by the banks participating in Tuesday’s auction. Second, the so much reported coordination effort can be put into question. From the amount offered by the ECB on Tuesday, an important part was probably demanded by US and UK banks. This limits the effectiveness of the informational content of the auctions held by US and UK Central Banks in their own countries. Third, some bail out might be going on despite continuous rejection of that thesis by ECB authorities. If we look back on the last two months, we saw many US institutions announcing large write downs because of the credit crunch. We have not seen so much reporting from the side of European institutions. Moreover even if this is just anecdotic evidence, given the transparency flowing around, this is all one can guess.

On the 18th the BoE auctioned 10 billion pounds in three month funds. Given the results of the auction the prompt impression is that some UK banks are closed out of the interbank money markets. The lowest accepted rate was 5.36 % and the highest accepted rate was 6.6 %, well above the official policy rate and 10 basis above the penalty rate of the discount window. The volatility of bid rates suggests that UK banks have different liquidity needs. Obviously, bids at the lower end got accepted. But there were also banks willing to pay rates higher than those in the money markets. This implies that if they are willing to pay as much as 15 basis more in the BoE auction where they have to give collateral as guarantee rather than borrowing in the uncolatellarized money market it is because they truly have no access to the money markets. The question is whether the auction disclosed any new relevant information. Probably, the auction will confirm banks that some of their peers have problems getting liquidity and banks will remain cautious on whom to lend. The auction just confirmed the adverse selection problem that exists in money markets. Nevertheless, the auction by the bank of England was successful at reducing the stress in the money markets with the three months pound LIBOR coming in 7 basis points after the auction

Last, on the US side, last week the Federal Reserve implemented two auctions through its new Term Auction Facility: the first was a $20 billion in 28-day credit held on December 17 and the second was a $20 billion in 35-day credit offered on the 20th of December. The one held on the17th of December resulted on: a stop rate of 4.65 %, with 93 banks bidding for 20 billion dollars and a bid/cover ratio of 3.08 (62.553 billion of dollars demanded vs. 20 billion dollars offered by the FED). The second auction resulted in a stop rate of 4.67 %, an smaller cover ratio (2.88) and a smaller number of participants (only 73 banks). Results suggest the following: First, given that the stop out rate came below the discount window rate, there seems not to be distress in the funding market. This is probably because many banks were already funded through year end and had not much interest on the auction. But also they could be relying on the most generous auctions held by the ECB. Second, given that the stop out rate was 40 basis points over the minimum bid this implies that most of the money was received by the most distressed institutions. Hence TAF was a good tool to channel liquidity where it was most needed.