Look How Far We've Come

Most investors measure the health of the economy by focusing on one metric: The Dow Jones Industrial Average.

That's unfortunate, and not because the Dow is made up of a small group of companies with names like General Motors and Citigroup (NYSE: C  ) -- which I'd hope aren't reflective of the broader health of the nation.

It's unfortunate because most of the chaos we've experienced over the past 18 months has been in the credit markets, which are obscure beasts that rarely get much attention. There seems to be little interest in having a caption at the bottom of MSNBC's newscast that says "Watching the LIBOR OIS spread."

But this is where all the action is  
Yes, we've all enjoyed the recent stock rally. But it's the recovery in credit markets that's really been impressive.

Looking at a basket of credit-market statistics shows that we've not only improved markedly since last fall, but are almost back to levels considered "normal." Have a look:

Metric

Brief Description

High Last Fall*

Current*

Normal*

 1-month LIBOR

 

Common measure of interbank lending -- higher levels show banks are scared of each other.

458

31

Shouldn't be much above Fed funds rate -- currently 0 to 25

TED Spread

 

Spread between 3-month Treasury bills and LIBOR (see more).

465

57

30-50

LIBOR OIS Spread

 

LIBOR minus Overnight Index Swap -- a key measure of how banks view the soundness of other banks.

364

55

26

A2/P2 Spread

 

Spread between high-quality and low- quality non-financial commercial paper -- measure of default risk.

586

47

20

*Basis points.

The stabilization in credit markets is encouraging for a few reasons:

  • The bulk of our economic pain -- from unemployment to stock swoons -- is ultimately linked back to the credit markets in one way or another.
  • Much of the downturn has been a factor of fear, uncertainty, and a lack of trust. The return to normal credit spreads shows most of this fear is abating.  

Consequently -- and reflecting pent-up demand -- the rush back into the credit markets has been a powerful one. In the past month, companies have been flooding the bond market to raise debt in amounts that would have been unfathomable late last year. Have a look:

Company

Amount of Debt Offered

Dow Chemical (NYSE: DOW  )

$6 billion

Microsoft (Nasdaq: MSFT  )

$3.75 billion

Bank of America (NYSE: BAC  )

$3 billion

American Express (NYSE: AXP  )

$3 billion

JPMorgan Chase (NYSE: JPM  )

$2.5 billion

Goldman Sachs (NYSE: GS  )

$2 billion

Odds are not one of these companies could raise a penny at anything less than ridiculous interest rates when credit market hysteria peaked last fall. The renewed credit health is a big, big deal that isn't getting enough attention these days.

But can it last?
The improvements have been so phenomenal that FDIC Chairman Sheila Bair recently (and courageously) claimed: "The liquidity crisis is over."

That's quite bold. Investors could have also called the liquidity crisis "over" in the fall of 2007, and the spring of 2008. Similarly, in April 2007, then-Treasury Secretary Hank Paulson proudly claimed "the housing market is at or near the bottom." That brave call, uh, didn't work out so well.

Since markets contain so many moving parts, bottoms (and tops) are notoriously hard to predict, and are usually blind guesses. No one has a clue whether we've truly seen the final bottom in credit markets.  

What is fairly certain is that the health of credit markets going forward will be a balancing act between two forces:

  • The Fed and Treasury implementing enough policies to convince investors that they won't let credit markets disintegrate on their own, as happened in the days after Lehman Brothers' collapse.
  • Those policies actually working.

Cross your fingers. Prepare for the worst. Hope for the best.
Our liquidity crisis last fall was originally precipitated by a solvency problem. That is, banks stopped lending to each other and credit markets froze not because of a lack of money, but because no one trusted whether a borrower would be able to repay their debt.

That said, most of the policies implemented by the Fed and Treasury have targeted liquidity issues, such as an extremely loose monetary policy, TALF, and preferred stock issued through TARP. Those have done a tremendous amount to pump liquidity into the system, but there's still much less clarity around the solvency issue. In other words, we've attacked the symptoms (illiquidity) more than the root causes (insolvency).  

And since solvency fears ultimately create liquidity problems, it isn't a stretch to assume that the credit market demons haven't been laid to rest just yet.

For related Foolishness:                                                                        

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. American Express and Microsoft are Motley Fool Inside Value picks. The Fool owns shares of American Express, and has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (22)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 21, 2009, at 1:00 AM, awallejr wrote:

    Finally someone else talking about this besides me. I usually get yawns. The LIBOR drop has been tremendous, and it is still dropping. Yes I dare say it, it IS a green shoot.

  • Report this Comment On May 21, 2009, at 9:00 AM, wberg wrote:

    In the art of full disclosure, you should probably note that the four financial services companies in your chart there are able to tap the debt markets in large because of the FDIC's temporary liquidity guarantee program. Among other things, the program guarantees senior unsecured debt of eligible institutions as long as it matures before June 30, 2012. Without the FDIC backing, the cost of senior unsecured debt for these entities would be much higher. The real question is whether or not the large financial institutions would be able to raise unsecured debt without government guarantees. There have been a few such debt raises but it remains to be seen. This is one of the main criteria the Treasury is going to use in determining whether or not the "too big to fail" institutions can repay TARP. I wouldn't be popping the bubbly quite yet there ace.

  • Report this Comment On May 21, 2009, at 10:28 AM, jackcrow wrote:

    The "Liquidity Crisis" may be abating but that does not mean it is a good time for individual investors to jump into debt markets. I give kudos to the above listed companies for noting that now is a cheap time to borrow. Just keep in mind if it is cheap for the borrower it is expensive for the lender. (a simple concept recently ignored by those whose business it is to lend)

  • Report this Comment On May 21, 2009, at 10:49 AM, TMFHousel wrote:

    "In the art of full disclosure, you should probably note that the four financial services companies in your chart there are able to tap the debt markets in large because of the FDIC's temporary liquidity guarantee program."

    All four financial companies raised the debt without the FDIC guarantee.

    -Morgan

  • Report this Comment On May 21, 2009, at 12:01 PM, PricePro12 wrote:

    Look at the Euro markets today, strange changes today look out.. As for this topic FDIC will not help.

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