3Europe and emerging markets), our roughestimates for expected writedowns during 2009and 2010, partly offset by the anticipatedrevenues over the same period, would result ina net capital shortfall in the order of magnitudeof at least half a trillion dollars. This impliesthat for U.S. and European banks taken togethersuch an amount in new capital is necessary justto prevent their capital position fromdeteriorating further. Moreover, forcefulmeasures to clean up banks’ balance sheets of troubled assets will be required to raise the levelof confidence in the banking system.Hedge funds and mutual funds have also beenhit hard, experiencing losses of assets undermanagement as investors shift to safer assetclasses. The combination of asset price declinesand redemptions suggest the hedge fundbalance sheets shrank by about half in the lastquarter of 2008, a particular concern for thosemarkets in which hedge funds provided asignificant proportion of market tradingliquidity.
Financing Gaps Widening
Despite capital injections and guarantees,funding markets are opening only slowly forbanks. Securitized forms of wholesaleborrowing are limited: current securitizationsare almost all retained on the balance sheet of the originators to use as collateral at centralbanks, while banks are unable to issue cost-effective unsecured debt unless it is governmentguaranteed. With the various governmentguarantee programs, banks have begun to raisesubstantial amounts of term funding to stabilizetheir balance sheets.Central bank liquidity injections and rate cutsare pushing down interbank rates, and furthergradual declines in term premiums areanticipated (Figure 3). However, despite mostbanks needing longer-term liquidity, much of the liquidity supplied by central banks is beingrecycled in the overnight market, or ends upback at the central banks, raising rollover riskseven further (Figure 4). This pattern reflectscontinuing worries about potential liquidityshocks and counterparty concerns, as well asuncertainty surrounding the amounts needed tofund future assets.
Figure 3. Spot and Forward LIBOR-OIS spreads* (bps)
Spot Mar-09 Jun-09 Dec-09
g; *On January 26 2009
Figure 4. Deposits at Central Banks (Billions of US Dollars)
Federal Reserve ECB Bank of England
Source: Haver Analytics, Federal Reserve, EUROSTAT, Bank of England
Looking forward, emerging market countries,particularly corporate borrowers, remainvulnerable to continued deleveraging andcredit retrenchment. Syndicated lending toemerging markets dropped sharply in thefourth quarter, as the contagion spread, withemerging Europe suffering a particularly sharpdecline. Emerging bond markets virtually shut