Opportunities in smallcaps header image 2

Credit crisis is easing fast

April 15th, 2009 · 2 Comments

And here is a tell-tale sign confidence in banks is returning…

Thank Bernanke for his rather audacious approach (which we happened to favour since the beginning of the crisis).

Libor Falling Fastest Since January on Credit Revival (Update2)
By Gavin Finch and Anna Rascouet

April 14 (Bloomberg) — The London interbank offered rate for three-month dollar loans is dropping at the fastest pace since January as bankers gain confidence that the worst of the financial crisis is over.

Debt strategists at Credit Suisse Group AG, Societe Generale SA and Royal Bank of Canada, three of the 16 banks that provide the data that sets Libor each day, say the declines will continue. Momentum may be building as signs of economic stability emerge, according to Federal Reserve Chairman Ben S. Bernanke.

“Not so long ago the main worry was whether the bank you’re dealing with was going to be around in three months time,” said Ira Jersey, head of U.S. interest-rate strategy at RBC Capital Markets in New York. “Now that concern is on the back burner. We’re going to see Libor coming down steadily.”

Libor, the British Bankers’ Association interest rate that determines borrowing costs on about $360 trillion of financial agreements ranging from home mortgages to corporate bonds, fell to 1.12 percent today from 1.32 percent a month ago. The fastest drop since the start of the year, when the rate tumbled to 1.08 percent on Jan. 14 from 1.42 percent nine days earlier, coincides with President Barack Obama’s efforts to restore the economy and the banking system to health.

The combination of plans to help banks get rid of devalued assets such as mortgage and leverage loans, the first back-to- back monthly increases in consumer spending since the first half of 2008 and an unexpected rise in home sales for February stoked optimism that the worst of the recession is over.

‘Intended Effect’

Bernanke told CBS Corp.’s “60 Minutes” on March 15 he saw “green shoots” in some financial markets. Fed programs to relieve disruptions in credit markets and restore the flow of credit “are having the intended effect,” Bernanke said April 3 during a speech in Charlotte, North Carolina.

Libor will decline to 1.04 percent by June, according to the average forecast of 12 banks on the BBA’s Libor panel surveyed by Bloomberg News April 6 through April 9, compared with 1.21 percent in a survey last month. Societe Generale, which bet on Libor rising as recently as February, says the rate will fall to 0.98 percent by the end of the quarter.

“There is a cautious optimism evolving that things are beginning to get better,” said Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York. He predicts Libor may drop to about 0.75 percent this year. “There’s a sense that things are going to go relatively smoothly through April with Libor continuing to fall.”

Failed Institutions

Lending between banks started to freeze in August 2007, when losses from subprime mortgages left financial institutions with billions of dollars in securities and financial contracts they couldn’t value. Credit markets contracted more in September 2008, when Lehman Brothers Holdings Inc. filed for the biggest bankruptcy in history.

More than 60 U.S. financial institutions have failed over the past two years. Global losses and writedowns have swelled to $1.29 trillion, helping to sink the global economy into its first recession since World War II.

As credit evaporated and stock markets tumbled, investors fled to the relative safety of gold and government bonds. In the five months following New York-based Lehman’s collapse, the MSCI World Index of stocks tumbled as much as 36 percent, gold soared 31 percent to $1,007.70 an ounce and the rate on U.S. Treasury bills fell to less than zero percent.

Government bonds returned 53 percentage points more than the Standard & Poor’s 500 index, according to Merrill Lynch & Co. data, the widest margin since the bank started calculating fixed-income returns in 1978.

London Fix

The gap between the Fed’s target rate for overnight loans between banks and Libor widened to 3.32 percentage points on Oct. 10 from 0.82 percentage point just before Lehman failed and an average of 0.22 percentage point in the five years before credit markets froze. The cost banks said they’d pay to borrow from each other soared even as central banks lowered benchmark interest rates and provided unlimited dollar funding.

Every morning, the London-based BBA surveys member of the trade group on how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies including dollars, euros and yen.

Now, strategists say, credit is starting to move again. The U.S. government and the Fed spent, lent or committed $12.8 trillion, the equivalent of 90 percent of last year’s gross domestic product, to stem the longest recession since the 1930s. Obama met with more than a dozen chief executive officers from banks including JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. on March 27, imploring them to get credit flowing through the markets again.

‘Aggressive Fiscal Expansion’

Governments’ stimulus measures worldwide will boost GDP by 1 percent to 1.5 percent this year, Deutsche Bank AG economists led by Peter Hooper in New York said in an April 8 report.

“Aggressive fiscal expansion will, in our view, play an important role in ameliorating the economic downturn and helping to lift the global economy out of its current severe recession,” the economists wrote.

In the past month, the MSCI World rose 15 percent and gold closed at $895 an ounce, down 13 percent from its record high. Treasuries posted their worst first quarter since 1999, losing 1.4 percent, including reinvested interest, according to Merrill Lynch’s U.S. Treasury Master Index. The index is down 0.7 percent so far in April.

Credit Costs

Consumer credit costs are still high by historical standards compared with what banks pay to borrow, an obstacle that Bernanke says must be removed to fix the economy. “Restoring the flow of credit to households and businesses is essential if we are to see, as I expect, the gradual resumption of sustainable economic growth,” Bernanke said April 3.

The difference in yield, or spread, between the average 30- year U.S. mortgage and 10-year Treasuries narrowed to 2.13 percent today, down from 3.07 percent on Dec. 19, which was the highest level since 1986, according to Bloomberg data. Still, the gap averaged 1.75 percentage points in the decade before the credit crisis began.

Credit-card borrowing rates are 10.23 percentage points above Libor, compared with an average of 9.91 percentage points in the past five years, according to Bloomberg data.

More losses by banks could trigger an increase in Libor, said Kurush Mistry, an interest-rate strategist at Barclays Plc in New York. “There’s still a lot of uncertainty regarding bank earnings and stress tests, and Libor could easily be shocked higher.”

Libor-OIS Spread

The International Monetary Fund is expected to raise its estimate of bad assets held by financial institutions worldwide to $4 trillion, the London-based Times newspaper reported April 7, without citing anyone. The IMF’s forecast for bad assets originating in the U.S. will increase to $3.1 trillion from a January estimate of $2.2 trillion, according to the newspaper.

The Libor-OIS spread, an indicator for banks’ willingness to lend, also remains elevated, while down from its highest levels. The measure narrowed to 0.92 percentage point, from 1.08 percentage points a month ago. It’s above the 0.25 percentage- point level that former Fed Chairman Alan Greenspan said would indicate markets were back to “normal.”

Contracts in the forward market show traders are betting the spread will fall to 0.82 percentage point by December, according to data compiled by Tullett Prebon Plc, the second- biggest broker of interbank transactions after ICAP Plc. It averaged 11 basis points between December 2001 and July 2007.

Economic Recovery

Bulls say Libor will decline because the U.S. economy is showing signs the recession will end later this year. The U.S. will expand at a 1.6 percent annual pace in the fourth quarter, according to the median estimate in a Bloomberg News survey of 74 forecasters.

Consumer spending, which accounts for more than 70 percent of the U.S. economy, rose 0.2 percent in February after climbing 1 percent in January, breaking a six-month string of declines. Orders placed with factories increased 1.8 percent in February, the first gain since July, the Commerce Department said. Purchases of existing homes jumped 5.1 percent to an annual rate of 4.72 million in February as lower prices attracted buyers, the National Association of Realtors said March 23.

Treasury Secretary Timothy Geithner’s plan to rid banks and markets of distressed assets heightened optimism the worst of the slump was past. The S&P 500 rallied 12 percent since March 20, the Friday before Geithner announced the program.

‘Less Stressed’

Pacific Investment Management Co., the Newport Beach, California-based manager of the world’s biggest bond fund, and New York-based BlackRock Inc., the largest publicly traded U.S. asset manager, said they may be interested in participating in Geithner’s Public-Private Investment Program.

The government programs have served to unclog rates beyond dollar Libor, the BBA said.

“Over recent months Libor rates have fallen in all currencies,” said John Ewan, a London-based director at the BBA. “We have also seen the spreads between individual contributor rates narrow. An interpretation of this could be that the markets are less stressed.”

Tags: Credit Crisis · Public Policy

2 responses so far ↓

  • 1 Darcy Patten // Apr 15, 2009 at 11:25 pm

    This is very good news. Perhaps, for the first time, we can see a light at the end of the tunnel.

    Of course this in turn will cause a economic recovery which will finally open the oil version of Pandora’s Box.

    This new millennium is sure shaping up to be an eventful one so far!

  • 2 admin // Apr 16, 2009 at 12:57 am

    Yes Darcy, these are promising signs, but we’re not there yet, but we can at least see a glimpse of light at the end of the tunnel