Man, it’s ugly out there. While the bailout of AIG prevented what was sure to be a meltdown, conditions in the credit markets show considerable distress:
Money market rates spiked up due to major money market fund Reserve breaking the buck and and the TED spread soared due to generalized worries about which firm might go into distress next:
The London interbank offered rate, or Libor, rose 19 basis points to 3.06 percent, the British Bankers’ Association said today. The increase is the biggest since Sept. 29, 1999, during the run-up to the new millennium. The difference between what banks and the Treasury pay to borrow, the so-called TED spread, widened 64 basis points to 283 basis points. That’s the biggest spread since Oct. 20, 1987, when stocks collapsed around the world on what became known as Black Monday.
“This is the second leg of the liquidity crisis,” said Guillaume Baron, a fixed-income strategist who specializes in money markets for Societe Generale SA in Paris. “We’re having another round of problems plus higher bank risk. This is what happened in August 2007 when the crisis started.”
In a flight to quality, three month Treasury yields dropped to their lowest level since 1954.:
Investors pushed the rate as low as 0.233 percent as the loss of confidence in credit markets deepened. Reserve Primary Fund, the oldest U.S. money-market fund, became the first in 14 years to expose investors to losses after writing off $785 million of debt issued by Lehman.
“People are extremely cautious with respect to who they’re lending money to at the moment,” said Richard Bryant, a Treasury trader at Citigroup Global Markets Inc., one of the primary dealers that trade government securities with the Federal Reserve. “They’re willing to buy very short-dated Treasury instruments and forgo returns and in some cases pay for the privilege of knowing their money is safe.”
Three-month bill rates fell 46 basis points to 0.23 percent at 9:34 a.m. in New York.
A 46 basis point move on 3 month Treasuries is massive.
Credit default swaps on Treasury debt have blown out to new levels. A mere eight months ago, CDS on Treasuries were a joke, hardly ever traded. They are now at 30. As Bloomberg tells us:
Benchmark 10-year credit-default swaps on Treasuries increased 4 basis points to 30, according to BNP Paribas SA prices at 6:45 a.m. in New York. The contracts have risen from below 2 basis points at the start of the credit crisis in July 2007 and are more than double those on government bonds sold by Austria, Finland or Sweden…..
“The latest bailout comes at the expense of the U.S. taxpayer,” Tim Brunne, a Munich-based credit strategist at UniCredit SpA, wrote in a research note today. “It cannot be expected that AIG will survive in its present form.”
I’m surprised at the gloomy reading on AIG. I think that deal will come to be regarded like the Chrysler bailout: a controversial, unprecedented move that paid off. Felix Salmon pointed out that the interest payments will be significant relative to US corporate tax receipts. But credit analysts are constitutional pessimists, and the AIG rescue raises the specter that any big financial player might be eligible,
As John Jansen noted:
If there are more transactions over time similiar to the one completed yesterday, the CDS will continue to be under pressure and I suppose ultimately the AAA rating would come under attack.
Increaded CDS spreads on Treasury debt is sending a warning signal. But will the powers that be heed? The reflation that took place during the Depression, when the US went off the gold standard in 1934, entailed a fall in the value of the dollar of roughly 40%. You would think the powers that be would recognize that our ability to trash the currency is constrained (or ought to be) by the risk of causing a currency crisis. But as noted in an earlier post, this crowd has run from expedient move to expedient move with perilous little aforethought.