Credit Crisis Worsens

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.

This is a companion discussion topic for the original entry at

[quote]Oct. 2 (Bloomberg) – Commercial banks and bond dealers borrowed $348.2 billion from the Federal Reserve as of yesterday, an increase of 60 percent from the prior week amid a worsening credit freeze.

Loans to commercial banks through the traditional discount window rose about $10 billion to $49.5 billion as of yesterday, the Fed said in a weekly report today. The total surpassed the previous record after the 2001 terrorist attacks.

Borrowing by securities firms totaled $146.6 billion, up from $105.7 billion. Under a new emergency program announced Sept. 19, banks borrowed $152.1 billion as of yesterday to buy commercial paper from money-market mutual funds, more than double a week ago.

The report reflects the Fed’s expansion of credit and emergency-lending programs to halt a yearlong credit crisis that pushed interest rates on three-month dollar loans today to a nine-month high as short-term corporate borrowing fell by the most ever.

The financial system is on a lifeline,'' said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. The Fed will have to maintain this expansion of its balance sheet for quite some time.‘’[/quote]




We are hearing that we have a liquidity problem. It seems to me that:

  1. This is a distraction. It is being created by the entities that have the problem, not by the people that don’t have a problem.
  2. The real issue is price. There is always a price at which an asset can be sold to another entity. That price may even be negative, meaning that additional terms are required to divest the asset.
  3. We need to be careful not to listen and adopt the language that their price problem is our liquidity problem. This will cloud your thinking and not allow you to think clearly about our situation. All ‘liquidity’ problems can be converted to pricing:
  • The price of money.
  • The price of labor.
  • The price of debt.
  • The price of assets.
  • The price for a politician to remain in office.

Would you comment?

"Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, ‘Account overdrawn.’" - Ayn Rand - Atlas Shrugged