While we all pay attention to the stock market and the failout, er, bailout bill and such, behind the scenes the credit markets are continuing to signal record levels of stress in the banking system.
First, the TED spread (definition here, worth your time if you are unfamiliar), a traditional measure of banking stress, hit another recent high today at 3.62 and closed the day at 3.61 – pretty much right at the high of the day.
A second measure of the reluctance of banks to lend to each other is the "Swap Spread," which hit a record today. Not a ‘recent record,’ but a record.
[quote]Oct. 2 (Bloomberg) — The spread between the rate on a two-
year interest-rate swap and surged to a record
as money-market rates climbed and concern increased about the
success of a proposed U.S. financial-rescue package. [/quote]
Together these measures tell us that banks are not lending to each other. They don’t trust each other. When banks don’t trust banks it is not a big stretch to conclude that they don’t trust anybody else either. This is a direct measure that the credit markets are in complete disarray.
A third measure is the London Interbank Offered Rate or LIBOR, which hit the second highest rate of the year today at 4.21%.
As reported today in CFO magazine:
[quote]The recent rise in Libor rates is a dire warning to borrowers that
interest rates won’t be dropping any time soon, according to a report
issued by Merrill Lynch.
Libor is the benchmark interest rate banks charge each other for short-term loans. The rate is based on what the world’s most creditworthy banks charge each other, so it is a starting point for the interest rates lenders charge less creditworthy borrowers — such as corporations. The rise in Libor is worrisome, emphasizes Merrill, because the rate is used to set the terms for numerous financial transactions.[/quote]
I recently wrote that September 19 would be remembered as the day that the markets changed forever. We are only now finding out why the extraordinary steps of that week were taken:
[quote]The credit crisis has played out in places most people cannot see.
It is banks refusing to lend to other banks – even though that is one
of the most essential functions of the banking system. It is a loss of
confidence in seemingly healthy institutions like Morgan Stanley and
Goldman – both of which reported profits, even as the pressure was
mounting. It is panicked hedge funds pulling out cash.
It is frightened big investors protecting themselves by buying
credit default swaps – a financial insurance policy against potential
bankruptcy – at prices 30 times what they normally would pay.
It was this 36-hour period two weeks ago – from the morning of Sept.
17 in New York and Washington, to the afternoon of Sept. 18 – that
spooked policy makers by opening fissures in the worldwide
financial system.
In their rush to do something, and do it fast, the Federal Reserve
chairman, Ben Bernanke, and the Treasury secretary, Henry Paulson Jr.,
concluded that the time had come to use the "break-the-glass" rescue
plan they had been developing.[/quote]
In short, most of the direct market action that you and I can observe from out here in the cheap seats is only minimally telling the tale of just how profound this crisis really is.
$700 billion? A meaningless amount, concocted in a moment of fear, that almost certainly has no bearing on the final amounts, whatever they may be.
Take care and be nimble. Things are shifting rapidly.
by cmartenson