In our previous article, How does a central bank ?set? interest rates?, we explained how the central bank set the interest rate. Today, we found an article from the Reserve Bank of Australia (RBA), Central Bank Market Operations, which explained central bank market operations (to set the target interest rate) in the light of the recent financial market instability.
In our earlier article, Consumers paying for the implosion of dumped risk, we mentioned about the ?cockroach theory:?
… if you see one cockroach in the kitchen, then there must more of them somewhere else. In the same way, if we see some of these crises in hedge funds coming to light, then there must be more of such rot somewhere else.
That article from the RBA said it nicely,
What seemed to be worrying people was that, while the US Fed had calculated the losses in the sub?prime market as being potentially as high as US$100 billion, only a few billion of losses had been announced by investment funds. This naturally led market participants to question who was sitting on the prospective losses, and what this meant for the creditworthiness of market counterparties. Investors became much more risk?averse and banks severely curtailed their lending to each other, causing gridlock in the money market. The process spread quickly because once banks started to worry that others may stop lending to them, they in turn stopped lending to others.
For those who are interested, it is a good read for learning purposes. For those who aren’t interested, it is a rather dry and boring article.
