Global Financial Stress Indicators

US money market funds have stopped lending to European banks. That’s evidenced by the $74.9 billion decline from $282.1 billion to $207.2 billion in the commercial paper outstanding of foreign financial issuers over the past 12 weeks through September 14. This funding squeeze must have worsened last week, prompting the ECB to start borrowing dollars from the Fed and three other central banks and loan the proceeds to European banks on an unlimited basis through the end of the year.

That action averted an immediate meltdown of the European banking system. Indeed, the FTSE Eurofirst 300 Banks Euro Index was down 32.7% ytd a week ago. Last week it rose 3.7%, with a jump of 8.8% from Tuesday through Friday. Unfortunately, coordinated central bank liquidity support can’t fix the underlying problem for European banks. They are holding large amounts of the bonds issued by debt-challenged European governments. If rescue measures fail to stabilize the finances of these governments, then the banks will need massive injections of new capital. Some might have to be nationalized, which would worsen the finances of their governments.