Interest Rate Cuts WIll fail to Build Trust Between Financial Institutions

By: David_Urban

A little more than a week ago a lone trader was able to rack up 4.9 billion euros in losses from trading in ‘plain vanilla' DAX futures. At the time of the discovery by SocGen officials, the losses were less than 2 billion euros. When the futures were sold off, the market crashed setting off a worldwide chain reaction which climaxed in the Federal Reserve cutting interest rates by 75 basis points.

The question on my mind is why the futures had to be sold off on the market immediately? SocGen notified the Governor of the Bank of France and the head of France 's AMF stock market when the rogue trades were discovered. The officials and counterparties could have worked together to alleviate the situation as the Federal Reserve did in the LTCM and Amaranth hedge fund situations. In each case, the Federal Reserve worked with counterparties to stem what would have been a major financial crisis in the markets.

When LTCM and Amaranth each collapsed the markets were under a much firmer financial footing but the markets would have had tremendous difficulty absorbing the positions responsible for the collapse. At the present time, counterparties in the marketplace are having difficulties working with one another which is causing extreme difficulties in more exotic derivative markets, not the more mature and developed ‘vanilla' futures markets.

Trust will not return between counterparties with rate cuts. Trust will only come with time and assurances that the values of the underlying assets are solid and transparent. In this instance, if there was trust between counterparties significant damage to the markets could have been alleviated.

One has to wonder what the ECB, who has so far been very transparent in their messages to the markets, was doing while the crisis raged on at SocGen. Did they give tacit approval to the selloff? Where was the European response? When did they notify the US Federal Reserve, before or after the cut? Why did they allow the Federal Reserve to respond to a European problem?

By David Urban

http://blog.myspace.com/global112

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