Credit crunch update

The “credit crunch” was at the heart of the media coverage of the financial crisis as it came to a crescendo last fall, but I haven’t heard much about it lately.  From what I do hear, the credit markets have loosened up quite a bit, with the big exception of mortgage loans that once got repackaged as securities.  Seems nobody wants to buy mortgage-backed securities (new or old) anymore, which is more than understandable.  I don’t either.

John Authers of the Financial Times recently noted that the commercial paper market, whose tightening last fall was evident in a big spike in interest rates, has eased considerably, as has the market for corporate bonds:

‘… there is evidence that banks’ problems may have been ring-fenced for the short-term. As Mark Lapolla of Sixth Man Research in California points out, use of the Federal Reserve’s commercial paper facility, for making short-term loans to companies, has dropped in the past few weeks, so businesses are finding other sources of finance. Large companies are issuing bonds after months when this was impossible.’

Authers seems to think the risk of a systemic collapse is now past:

‘The market believes that financial stocks could go to zero without damaging the rest of the economy. They are down 28 per cent for the year while no other sector is down more than 12 per cent.’

That seems to me an odd way to read the market, but it may well be that the worst of the financial crisis is behind us, if the banks’ problems have not yet led to a collapse of credit intermediation and if the collapse of financial stock prices has not been very contagious.  (Such a collapse may be uppermost in Ben Bernanke’s mind, as one of his most seminal papers was about the collapse of credit intermediation in the early 1930s as the dominant factor in the Great Depression.  He has also written about the “credit crunch” in the early 1990s recession).

What about other indicators?  Last fall was when “TED spread” (LIBOR – T-bills rate) became almost a household word, and when the NYT began running an excellent interactive chart of five key interest rates and indicators (TED spread, LIBOR, T-bill rate, commercial paper rate, junk bond rate).  Let’s take a look at each:

TED spread: about 1% for more than a month now, down a ways from its October 2008 peak of 4.6% but still about four times as high as its 2002-2006 average of about 0.25%.

LIBOR: about 1.25%, also down a ways from its October peak of nearly 5%.  Has risen a bit from its early January low of about 1%.

90-day T-bill rate: about 0.25%, still very low, but had been nearly 0% from mid-November to mid-January.  This is the interest rate that has an inverse relation with credit tightness, since T-bills are a traditional safe haven compared with other bonds.  T-bill rates had been about 1.75-2.00% in the months prior to Bear Stearns’ implosion in September 2008, so it seems the flight to safety has yet to land.

commercial paper rate: about 0.4%, about where it’s been since mid-December.  Commercial paper rates jumped from about 2.5% in the months before the crisis and peaked at over 4% in October, but they came down pretty quickly, possibly following the Fed’s reductions in another short-term rate, the federal funds rate.

junk bond rate: about 18% right now, still pretty alarming.  Not as bad as in October-December, when it was in the range of 20-25%, but a lot higher than before the crisis hit (about 10-13% in May-mid-September).  Clearly bond investors’ expectations of defaults are a lot higher than normal.

In sum, it looks like we’re not out of the woods yet, especially as regards the junk-bond market and the continued flight to safety in T-bills, but the credit crisis has eased quite a bit.  The big question is what happens if and when several big banks flunk their “stress tests” and are revealed to be insolvent.

UPDATE, 21 Feb. 2009:  Kevin Hall & Tony Pugh of McClatchy Newspapers had the following summary of the credit crisis:

‘As to unfreezing the credit markets, at this point the goal isnt to have people borrow beyond their means but borrow at all. Car sales are evaporating, student loans are drying up, credit card rates are rising and the slowdown in borrowing is needed, not just as abruptly as it has happened.’

Back in early January, Heidi N. Moore of the WSJ offered a moderately optimistic assessment, noting several successful issuances of debt while cautioning that the market for sub-investment-grade debt (i.e., junk bonds) is still hurting.  Citing a Fitch ratings agency report, she says

‘… 2008 was a “disastrous” year for high-yield offerings, during which total return on the Merrill Lynch High Yield Master II Index (Master II Index) was a negative 26.39%, sharply below the 2.19% rise of 2007. High yield issuance also declined sharply during the fourth quarter of 2008, falling to just $1.44 billion from $34.5 billion during the comparable 2007 fourth quarter…’

Small wonder, then, that investors are avoiding junk bonds.  (And the absolutely scandalous rubber-stamping of subprime mortgage debt as AAA by Fitch and other agencies surely contributes to investor leeriness.  I’m guessing that wasn’t in their report.)  And with the high interest rates that are now clearing that market, it’s no wonder that most companies are looking elsewhere to raise funds.  At this point the junk-bond market looks like a classic “lemons” or adverse selection problem.

But that market is showing a bit of improvement.  The percentage of junk bonds “in distress,” defined as offering interest rates 10 percentage points higher than Treasury bonds, fell from 84% in November 2008 to 69% in January 2009.   Still a long way to go, however.  That percentage, or “distress ratio,” was only 27% in August and was down around 1% in the first half of 2007.

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3 Responses to “Credit crunch update”

  1. democommie Says:


    How about that Texas investor who got nabbed by the Feebs yesterday? Another $8B or so, according to news reports.

    • Ranjit Says:

      Yeah, Robert A. Stanford sounds like a populist Madoff. Instead of ripping rich people off with an opaque investment trust, he apparently ripped off people from all walks of life with good old certificates of deposit. Albeit CD’s that promised a higher interest rate than was mathematically possible from a bank’s normal assets in these low-interest-rate times.

  2. democommie Says:

    Just goes to show, there IS a sucker born every minute and a lot of them have advanced degrees or mad tek skilz.

    There was a guy on the radio (NPR?) the other day talking about how the lack of math literacy in this country contributes to folks being duped by such schemes and others like ARM’s. I can’t do math (alg, trig, calc) to save my life, but I understand numbers like a pawnbroker.

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