We hate the original Hanke-Panke plan, and we doubt we’re going to like the final version much. We think there are better solutions. But we do think the government needs to do something–and soon.
In his weekly newsletter, Thoughts From the Frontline, analyst John Mauldin explains the crisis in detail. The bottom line is that, as confidence has collapsed and investors have fled the corporate credit markets for the safety of Treasury bills, the cost of short-term corporate borrowing has soared. This is choking off the economy’s air supply.
The situation got serious after Lehman Brothers failed. Lehman was the first major collapse in which not just stockholders but bondholders were allowed to get hurt. After Lehman, those who buy commercial paper and other short-term debt instruments knew they could no longer count on being protected, and the flight to safety began in earnest.
Here’s an excerpt from John Mauldin’s newsletter, which is distributed via email. To read the whole thing, click here and sign up.
There is something called the TED spread, which is the difference between three-month LIBOR (the London Inter Bank Offered Rate which is in euro dollars, also called The Euro Dollar Spread, thus TED) and three-month US Treasury bills. Three-month LIBOR is basically what banks charge each other to borrow money. Many mortgages and investments are based on various periods of LIBOR. Look at the chart below. Typically the TED spread is 50 basis points (0.50%) or less. When it spikes up, it is evidence of distress in the financial markets. The last time the TED spread was as high as it is now was right before the market crash of 1987. This is a weekly chart, which does not capture tonight’s (Friday) change, which would make it look even worse. Quite literally, the TED spread is screaming panic.
The Fed has lowered rates to 2%. Typically, three-month LIBOR tracks pretty close to whatever the Fed funds rate is. Starting with the credit crisis last year, that began to change. Look at the chart below.
Remember, LIBOR is what banks charge to each other to make loans. Lower rates are supposed to help banks improve their capital and their ability to make loans at lower interest rates to businesses and consumers. Look at what has happened in the past few weeks, in the chart above. The spread between three-month LIBOR and the Fed funds rate is almost 200 basis points, or 2%! That is something that defies imagination to market observers. On the chart above, it looks like it has not moved that much, but in the trading desks of banks all over the world it is a heart-pounding, scare-you-to-death move. The chart below reflects what traders have seen in the past two weeks, and it moved up more today.
Now let’s look at the next chart. This is the amount of Tier 1 commercial paper issued. This is the life blood of the business world. This is how many large and medium-sized businesses finance their day-to-day operations. The total amount of commercial paper issued is down about 15% from a year ago, with half of that drop coming in the last few weeks. Quite literally, the economic body is hemorrhaging. Unless something is done, businesses all over the US are going to wake up in a few weeks and find they simply cannot transact business as usual. This is going to put a real crimp in all sorts of business we think of as being very far from Wall Street.
I could go on. Credit spreads on high-yield bonds that many of our best high-growth businesses use to finance their growth are blowing out to levels which make it impossible for the companies to come to the market for new funds.
We had lunch with a bank analyst on Friday who said the situation was so serious that if the government didn’t have a deal in place this weekend, the stock market would open down “thousands of points” on Monday. This is a bit hysterical–the market will continue to discount an eventual deal until we get one–but the analyst did persuade us that the damage from the high short-term borrowing costs would quickly ripple through the rest of the economy.
So this is, in fact, the time for the government to act. We just wish we had more confidence that the deals on the table are likely to be effective.
See Also: LIVE: Bailout Negotiations
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