Banks tighten credit, borrowing rates soar

Published: Wednesday October 1, 2008

Bank-to-bank lending rates jumped Tuesday and Treasury bill demand eased only slightly, a day after Congress' rejection of the bank bailout plan cast an even deeper freeze over the barely operational credit markets.

After the House's vote against the Bush administration's plan, investors pulled their money out of stocks and commodities Monday, sending the Dow plummeting 778 points and crude down more than US$10 a barrel.

That money got shovelled into Treasury bills, short-term debt issued by the US government that's considered the safest investment around.

On Tuesday, the yield on the 3-month T-bill recovered to 0.90 per cent from 0.14 per cent late Monday as the Dow Jones industrial average rebounded by more than 260 points in midday trading.

Lending rates

The T-bill yield is still very low by historical measures, however - particularly when compared to lending rates between financial institutions.

Banks were in miser mode after the House's rejection of the rescue package.

The key bank-to-bank lending rate, the London Interbank Offered Rate, or LIBOR, soared to 4.05 percent from 3.88 per cent for 3-month dollar loans, and to 6.88 per cent for overnight dollar loans - the highest level since tracking began in 2001.

That's especially worrisome because normally, LIBOR is just slightly above the Federal Reserve's target fed funds rates, an interbank lending rate. Now, it is more than 4 percentage points above the target rate of two per cent.

That has troubling implications for other lending rates tied to LIBOR, including homeowners' adjustable rate mortgages.

Financial contracts tied to Libor amount to more than US$300 trillion - or US$45,000 for every person in the world.

Central banks around the world have been ramping up their lending in an effort to keep the markets functional. On Monday, the Federal Reserve said it was doubling the total amount of cash loans to banks to US$300 billion, and making $620 billion available to other central banks through currency swap arrangements, up from US$290 billion.

Liquidity

Those efforts, however, have done little to encourage lending.

"There's so much liquidity in the system - unfortunately, the liquidity is not opening up lenders at all," said Kim Rupert, managing director of global fixed income analysis at Action Economics.

"It's the epitome of credit turmoil. There's too much fear in the market. Everybody is hoarding their cash, hoarding their reserves, not trading funds with each other."

For big companies to operate and grow, they need to borrow money. Typically, they do this by selling short-term and long-term bonds in the credit markets.

Right now, the short-term debt markets are at a standstill; the long-term debt markets are a bit more functional, but rates are very high.

Alternative

Companies in search of cash do have an alternative - they can go directly to the bank. But banks have their own problems with capital right now, so a company trying to get a loan has about asmuch luck as a person trying to get a mortgage.

Those with clean credit histories will likely get loans, but at high rates. Those with spottier credit histories might not get loans.

"In a good case scenario, the economy is slow. In a bad case scenario, there are massive bankruptcies," said Axel Merk, portfolio manager at Merk Funds.

"The problem is, the general public doesn't understand this. Maybe we need to see a few payrolls fail at a few companies before they realise," he said.

Direct impact

"This has a very direct impact on Main Street."

After shooting up on Monday longer-term Treasury prices pulled back, pushing yields higher.

The 2-year note fell 20/32 to 100-3/32, and its yield rose to 1.95 per cent from 2.13 per cent.

The 10-year note fell 1-16/32 to 101-31/32 and yielded 3.76 per cent, up from 3.58 per cent.

The 30-year note fell 2-14/32 to 105-15/32, and its yield rose to 4.24 per cent from 4.12 per cent.


Source: Jamaica Gleaner
http://www.jamaica-gleaner.com/gleaner/20081001/business/business9.html