Credit Crisis Watch: Market Confidence Still Frozen

Are the various central bank liquidity facilities and capital injections having the desired effect of unclogging credit markets and restoring confidence in the world’s financial system? This is precisely what the “Credit Crisis Watch” is all about - a regular review of a number of measures in order to ascertain to what extent the thawing of credit markets is under way.

First up is the LIBOR rate. This is the interest rate banks charge each other for 1-month, 3-month, 6-month and 1-year loans. LIBOR is an acronym for “London InterBank Offered Rate” and is the rate charged by London banks. This rate is then published and used as the benchmark for bank rates around the world.

After having peaked on October 10, 2008 at 4.82%, the 3-month dollar LIBOR rate declined sharply to 1.08% on January 14, 2009 but the healing process has since not made headway, with the current rate at 1.23%. LIBOR is therefore trading at 98 basis points above the upper band of the Fed’s target range - a great improvement, but still steep compared to an average of 12 basis points in the year before the start of the credit crisis in August 2007.


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Importantly, US 3-month Treasury Bills have been heading higher, especially over the past few days, to 0.32% after momentarily trading in negative territory in December 2008 as nervous investors “warehoused” their money while receiving no return. The fact that some safe-haven money is now coming out of the Treasury market is a good sign.

US 3-month Treasury Bill yield


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The TED spread (i.e. 3-month dollar LIBOR less 3-month Treasury Bills) is a measure of perceived credit risk in the economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. An increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. On the other hand, when the risk of bank defaults is considered to be decreasing, the TED spread narrows.

Since the TED spread’s peak of 4.65% on October 10, 2008, the measure has eased to a 7-month low of 0.91% - well above the 38-point spread it averaged in the 12 months prior to the start of the crisis, but nevertheless a strong move in the right direction.


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