The Big Credit Freeze Starts To Thaw
By Gus Krafve
December 4th, 2008
The economic news is still negative, but the data tells us that the credit markets are thawing. Prime mortgage, LIBOR and commercial paper rates have all been steadily declining. This news hasn’t made the headlines, but let’s be honest, good news doesn’t sell newspapers.
In late November, the Federal Reserve announced that it would buy $500 billion worth of mortgage-backed securities over the next eighteen months. Since the announcement, the rate on the 30-year conventional mortgage dropped a half percent to roughly 5.75%. The current rate is one percent lower than last month and is only about a quarter percent higher than the all-time lows set back in 2003.
The one month London Interbank Offered Rate (LIBOR) has been falling steadily and is currently 1.44%. The LIBOR rate is the rate at which banks can borrow unsecured funds in the wholesale market. This rate, which spiked up to 4.58% in mid-October, has been declining steadily since the Treasury, the Fed and the FDIC have been aggressive in solving the current crisis and injecting massive amounts of liquidity into the financial system. The spike in the LIBOR rate last month reflected the lack of confidence in commercial banks ability to repay debt. The subsequent decline indicates that confidence is returning regarding the banking system’s ability to repay its loans.
Finally, like the declines seen in mortgages and LIBOR, commercial paper rates have also been declining. The commercial paper market is a $1.7 trillion dollar debt market and is vital to many of the nation’s largest corporations. Commercial paper is short-term borrowings by companies with a fixed maturity of one to 270 days. These rates began to move higher in mid-September and peaked in mid-October at rates of over 6% in some cases. Several companies had trouble accessing this market as investors had begun to stop buying this short-term debt. On October 7th, the Federal Reserve announced that it would provide a liquidity backstop to issuers of commercial paper. Not all companies are eligible, but this move by the Fed has restored order in this market.
In addition, the FDIC announced on November 21st under the Temporary Liquidity Guarantee Program (TLGP), that it is guaranteeing newly issued debt by banks, savings and loans, and certain holding companies. Any debt issued on or before June 30, 2009, will be fully protected though June 30, 2012. Goldman Sachs and Morgan Stanley were quick to issue debt under the new program, and there are sure to be several more financial institutions to follow. Both companies are now able to issue FDIC insured debt at rates close to 3%, which is a considerably lower rate than was previously available.
The ability to borrow money at reasonable rates is an integral part of the business plan of most firms and it is also critical to their survival, just like it is for most households. Big business operates just like small farmers who borrow money in the spring for seed, fertilizer and fuel in order to plant a crop, harvest it in the fall, sell it for a profit and pay back their loan. The plan works as long as the farmer has the ability to borrow money when it’s needed; if he can’t, then the crops won’t get planted and his business will fail, not because his business plan is bad or unworkable, but because he doesn’t have the available cash when he needs it to put in his crop. Freeing up the credit market is a big deal to investors because it allows the firms they own to borrow money, sustain operations and make a profit, which by the way is a good thing.
