Central banks need new playbook to tackle credit crisis

By Sumeet Desai - Analysis

LONDON (Reuters) - The global financial crisis that has raged for months shows no signs of ending and the chiefs of the big central bank chiefs are scratching their heads over how to restore faith in the world's credit markets.

Global policymakers have unveiled a catalogue of measures since August 2007 to try and return confidence to markets. All have failed and left in their wake multi-billion dollar banking casualties in the United States, Britain and Germany.

Massive injections of emergency funds worth hundreds of billions of dollars, a giant $150 billion U.S. economic stimulus package and wholesale rewriting of the rules to allow commercial banks to pledge risky assets to secure high quality central bank funds, have all come to nothing.

Banks will still not lend money to each other in the wholesale interbank market that ordinarily provides the lubrication to keep the global financial system turning because the fundamental problem that remains to be tackled is how to put a floor under plunging U.S. real estate prices.

"The mortgage problem in the U.S. is a direct consequence of a failure of policymaking through the 1990s and it's going to take corrective action from policymakers to sort it out," Paul Markowski, president of New York-based investment advisory firm Global Research Partners, told Reuters.

"Some form of mortgage bailout is likely to have to feature at the core of the solution and that's what central bankers and regulators are now coming to terms with."

So far, central banks have only been prepared to lend against mortgage-backed securities -- one of the fastest growing area of the global capital markets and worth about $4.5 trillion -- rather than buy them outright.

A Financial Times Story on Saturday said officials in the U.S., the UK and the euro zone were now in talks about the feasibility of mass securities purchases using public funds as a solution to the credit crisis, but the Federal Reserve and the Bank of England dismissed the story. The European Central Bank declined to comment.

COLOSSAL PROBLEM

The scale of the problem the leaders of the world's banking system face is colossal.

Banks have written down over $125 billion of assets since November alone, hammering their shares.

Another raft of credit-related writedowns are expected to be announced this week when the latest batch of quarterly results from the global banking industry are published.

Ratings agency Standard & Poor's said earlier this month that the total bill for U.S. subprime losses could hit $285 billion. The ripple effect from losses booked so far has forced bank bailouts in the U.S. and Europe and asset price writedowns from Berlin to Beijing.

The S&P/Case-Shiller index of all U.S. house prices fell by 8.9 percent in the fourth quarter of 2007 versus Q4 2006, the biggest drop in the survey's 20-year history and more than three times the rate of decline at the peak of the 1990-91 U.S. housing recession. Prices in Miami fell 17.5 percent on the year.

Subprime mortgage losses were bad enough on their own, but that problem is now compounded by plunging property values that have impaired portfolios of even high quality mortgage assets and made it impossible, at least so far, for credit investors to gauge when the U.S. real estate slide will come to an end.