Morning Line: Banks cheer more taxpayer cash as the economy crumbles

The global economy is grinding to a halt, housing markets across the world are collapsing, millions of ordinary folk are being squeezed to breaking point - and yet financial markets have enjoyed a massive bounce in recent days.

What is going on?

The answer is that western governments have yet again elected to use taxpayers’ cash to bail out the big financial institutions. The sound of Wall Street rallying last night was the sound of wealthy bankers clinking champagne flutes and breathing an enormous sigh of relief, reassured that that their misdeeds were yet again being rewarded with more piles of cheap dollars.

Predictably, it was the US Federal Reserve which spearheaded the latest bank support operation. The US central bank last night announced it would be offering three-month loans to cash-strapped Wall Street banks, as well as extending its existing emergency loan facility for banks and primary dealers for at least another six months. The latter move is something the Fed had steadfastly refused to do until now.

Crucially, the Fed is also to create a new options auction facility which will allow Wall Street banks to swap low-quality illiquid securities (nasty mortgage securities, for example) for rock-solid government bonds.

On this side of the Atlantic, meanwhile, the European Central Bank and the Swiss National Bank followed the Fed’s lead in offering their own three-month loan facility, through an offshore facility set up in conjunction with the US central bank.

Announced with less of a fanfare, meanwhile, but perhaps equally important, was last night’s move by the US Financial Accounting Standards Board to delay new tougher rules on bank accounting.

The new rules would have forced banks to move billions of dollars of debt assets (nasty mortgage securities, for example) out of off balance sheet investment vehicles and onto the company balance sheet. These crafty vehicles were a key way in which banks were able to hide the amount of risk they were racking up in the years of plenty.

The new FASB rules would have forced banks to bring these toxic liabilities into full public view. This in turn would have forced many banks to increase their capital reserves in order to protect depositors - something which understandably worried shareholders and bank executives.

But they need worry no more - for the next year at least. The FASB last night ‘regretfully’ announced that the new rules are to be delayed for a year, to allow banks more time to adjust to the new regime.

‘It does pain me to allow something that has been abused by certain folks, to let that go on for another year,’ the FASB chairman Robert Herz is reported as saying.  

All told, then, it was little surprise then to see investors whoop for joy. It was a day of big victories for the Wall Street masters of the universe.

And yet, close to a year in, the credit crisis show no signs of ending, and indeed many banks are arguably in an even bigger hole than they were six months ago. Despite recent huge writedowns by the likes of Merrill Lynch, overall subprime liabilities remain uncertain and banks remain coy about coming clean.

When central bankers and governments argue that markets are not functioning properly, they are being deliberately disingenuous. They are in fact functioning perfectly well; banks are not lending or investing with each other because they know what a mess they are all in. Only the central banks, playing with other people’s money, are prepared to buck the markets; as has been often remarked, the free market has become a free lunch market.

Perhaps even more worrying, the crisis now shows signs of spreading to the real economy, prompting sharp slowdowns or even recessions in all the major trading areas, including the UK, Euro area, US and Japan. Banks may well see credit quality deterioration spread to supposedly higher quality debt, for example prime or near-prime mortgages or commercial debt. If and when default rates in these sectors spike up we may see the intricate global financial network unravel even further.

But through it all, bankers can sleep safe in the safe knowledge that public money will always be on hand to save the day. Indeed, it's onwards and upwards for some - Morgan Stanley today proudly boasted of plans to use the current downturn to make already wealthy bankers even wealthier. Having slashed nearly 5000 jobs earlier in the year, Morgan Stanley has revealed that of the $1 billion saved some $400 million had already been distributed to remianing key staff in the form of wage rises and bonsues. The rest, it says, will be used to hire some more top quality banking talent.

As you worry about your job, or watch the value of your house plummet, or receive that first £100 a month fuel bill, remember that. It’s a sobering thought.