Fed’s Not Ready To End Life Support

The Fed has announced that it’s extending the maturity of most of its alphabet soup of lending programs from the end of the year until February 2010. Here is the opening paragraph of their statement:

The Federal Reserve on Thursday announced extensions of and modifications to a number of its liquidity programs. Conditions in financial markets have improved in recent months, but market functioning in many areas remains impaired and seems likely to be strained for some time. As a consequence, to promote financial stability and support the flow of credit to households and businesses, the Federal Reserve is extending a number of facilities through early 2010. At the same time, in light of the improvement in financial conditions and reduced usage of some facilities, the Federal Reserve is trimming the size and changing the terms of some facilities.

You can check out the entire press release to see what’s happening to your favorite program.

At this point in time the financial markets are hooked on central bank support throughout the world. They have improved only in the sense that counterparties trade with one and other on the presumption of sovereign support. Until that support is withdrawn it seems to me relatively impossible to assess the true functionality of the markets.

I found this article that was published a couple of days ago by MarketWatch pertinent:

Who says the credit crunch is over?

Not banks that operate in the euro zone, evidently. The European Central Bank issued a pretty simple proposition: borrow whatever you want, for one year at 1%.

The answer to that historic first was — yes, please!

Over 442 billion euros, or over $600 billion, was lent. That was more than the loosely-pegged 300 billion euro consensus, though short of some whispers that up to 1 trillion euros would have been allocated.

And who could blame the banks?

True, they can borrow for even more cheaply than 1%. Three-month and six-month inter-bank lending rates in the euro zone are running over a quarter-point lower than that.

And whatever the hawkish noises from ECB members like Axel Weber, interest rates aren’t going up anytime soon with the euro-zone economy stuttering as it is.

But the reason banks evidently lined up from Espoo to Frankfurt for the cash was counterparty risk.

There’s the very real risk of Latvia blowing up. Or Central Europe. Or maybe even one of the mega-banks of Europe for that matter, whatever the latest sell-side notes proclaim.

At least that must be the view from the treasuries of Europe’s banks.

It’s entirely possible that it might take multiple years to wean the financial markets from state support. The longer it takes the greater the risk that it never happens. Politicians are going to tire of defending support to their constituents particularly if it appears that the financial institutions are reaping excessive rewards while relying on taxpayer subsidies. The end game could then become either outright nationalization or crippling restrictions on the financial systems business models.