While the politicos in D.C. navel gaze and ponder how to win their next election, Rome is burning. You see, the markets don't care about your Senate seat or whether the "fat cats" are going to get bailed out.
What matters right now is that the credit markets are at a standstill. People can't borrow and businesses around the globe that rely on the short-term liquidity of the credit markets are being badly hurt. We won't hear about the brilliant entrepreneur denied her small business loan, but how about McDonald's
Sure, you still see advertisements for mortgage loans, but have you tried to get one? A colleague of mine with an excellent credit rating made the attempt and was quoted 11% for a 30-year fixed mortgage with a 20% down payment. That's the equivalent of the "open" sign being left on, but the doors being locked. A survey conducted by The Association for Financial Professionals of many large-company finance executives found that the locked-up credit market has already caused them to stop hiring and to cease capital spending projects.
The media isn't focusing on that so much (and shame on them). They'd rather focus the attention on raw-meat issues like limiting CEO compensation. As if that matters right now.
Fool, meet TED -- Ted Spread, to be specific. The TED Spread is the difference in rates between the interest rate paid on three-month U.S. Treasury Bills (the "T"), widely considered the most secure of all investments, and the three-month Eurodollars (the "ED") contract, represented by the London Interbank Offering Rate, or LIBOR. (Eurodollars are, quite simply, U.S. dollar-denominated deposits held at banks outside of the United States.)
The spread is a measure of the credit risk that the market perceives in the general U.S. economy. It measures the rate of return the banks are requiring over the risk-free Treasury Bill rate to lend to other banks.
It shows the level of concern banks have that other banks are going to default. It is, if you will, one of the purest measures of the perception that banks are going to fail -- kind of a measure of our economic blood pressure. When the economy is strong, the TED spread is quite low. But when the economy weakens in systemic ways, it can skyrocket as banks choose to sock their assets away in Treasuries rather than take a chance that another bank will default. Call the TED spread an indicator of the risk of an economic heart attack.
Historically, the TED Spread has been around 0.5%. Just prior to the past two recessions, 2001-2002 and 1990-1991, the spread exploded to around 1.25%.
When the Paulson financial recapitalization plan failed to pass the House of Representatives yesterday, the TED spread shot up to an all time high of 3.5%. If the economy were a medical drama, doctors would be running around shouting "Push 500mls of (insert drug name here), stat!"
Keep in mind that the raised TED Spread is a sign of the perception of credit risk. It doesn't mean that the credit market is seizing up. It means that those who are in the best position to know think that the chances of default are much higher, and that they demand compensation from other banks in the form of a much higher interest rate as a result. That is expensive, and it means that some banks might reasonably refuse to cash checks drawn on other banks. If things get much worse, $700 billion will look like a bargain.
Here's a solution for our elected officials: Put a provision in the bill that ups the FDIC insurance limit from $100,000 to $250,000. Restoring customers' confidence in their deposits reduces the risk of withdrawals that sealed the fate of Washington Mutual
That'd pass in a heartbeat, and it'd likely quell the anger of their constituents.
David Forrest does not own shares of any company mentioned. Bill Mann owns shares of McDonald's. The Home Depot is a Motley Fool Inside Value recommendation. The Motley Fool is investors writing for investors.