Credit Markets Roiled Despite AIG Rescue

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.

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  1. ndk

    Speaking of the gold standard, ol’ shiny and useless is up 6% today. There must be a lot of really scared people out there.

  2. Cash Mundy

    Who is writing swaps on Treasuries? AIG? What currency are they payable in?
    Maybe if they are written by a Chinese bank and payable in bags of rice, they might be worth something. Payable in US$? By a US financial institution? I don’t know much ’bout no swaps, but I think that dog don’t hunt.

  3. Anonymous

    With no planning or forethought but just knee jerk reactions from the Fed and the Treasury, there is no way the dollar will survive in its current valuation. The game is already over as the forces in play far exceed the governments capacity to control it. The only thing they have left to fall back on is their vaunted free market ideology that started this whole mess. And you ain’t seen nothin’ yet. Just wait for president McCain’s permanent tax cuts and Treasury Secretary Phil “no whining” Gramm. That’s when things will really get fun.

  4. Anonymous

    The bailout is working (rolls eyes) so far or the SOW would be at 10,000 and below.

    Russian markets halted for the second day in a row, couldn’t happen to a nicer group of socialists, oh wait, were next.

  5. Matthew Dubuque

    Matthew Dubuque

    This phenomenon would have been FAR worse today (and it will amplify) had the Fed NOT acted to euthanize AIG (rather than allow the repercussions of an extreme and violent death).

    The policy goal may now be forced to shift to attempt a VERY hard and forced landing for the global economy instead of a crash landing that would indirectly kill millions worldwide over the next ten years.

    Previously a hard landing was the hope. But that has changed. The likelihoods are shifting to a VERY hard and forced landing or worse.

    We need Paul Volcker in charge of the global crisis management team. We need that now.

    Matthew Dubuque

  6. Anonymous

    Do you know where in line the Fed is with regard other Lehman debtholders with what it lent through the alphabet soup windows?

    The bigger question is obviously, will taxpayers take a direct hit because whatever is lent through the windows goes away/isn’t recovered in a bankruptcy? Or is the Fed atop the creditor list.

    I don’t know about you, but I don’t see why Barclays should walk away with prime ex-Lehman assets financed by me.

  7. RN

    The problem is that so many asset prices were bid up because of an unrestrained credit bubble. In the absence of fundamental support, those prices cannot be sustained, and as we see now the fear during a credit deflation can be more powerful (and certainly more rapid) in effect than the greed during credit inflation.

    The common perception is that a more sensible regulatory structure should be put in place after the “damage is done”. In my opinion, this is backwards. The regulatory structure should be written and implemented NOW so that new firms can spring up operating under the clear new rules of the game and replace the ones with the opaque balance sheets, and begin to provide the credit and the confidence that is desperately missing now.

  8. Anonymous

    I hope you US-people still can put faith in your leaders…


    Reid Says `No One Knows What to Do' to Solve Crisis (Update2)

    By James Rowley and Brian Faler

    Sept. 17 (Bloomberg) — The U.S. Congress is unlikely to pass new legislation to overhaul financial regulations this year because “no one knows what to do,'' Senate Majority Leader Harry Reid said today.

    “We are in new territory, this is a different game,'' Reid said at a briefing in Washington. Neither Federal Reserve Chairman Ben Bernanke nor Treasury Secretary Henry Paulson “know what to do but they are trying to come up with ideas,'' Reid said.

  9. doc holiday

    Here is spread:

    From Yves Vault: THURSDAY, APRIL 17, 2008
    Why the Happy Talk About the Credit Crisis?

    I am frequently mystified at what goes on in the markets. I am even more mystified when people who ought to know better make pronouncements that appear to be profoundly counter-factual. Even if they are talking their own book, the high odds of being revealed as bald-faced liars proven wrong ought to make them worry about damaging their credibility.

    Is this wishful thinking? Delusion? A hope that that a united front can change perceptions and therefore reality? (see this as Tinkerbell behavior: if we all clap together, the markets won’t die).

    See Also: OIS (overnight index swap)

  10. Anonymous

    “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.” — Yves Smith

    I guess the question is, which kind of crisis do you prefer — an economic crisis, or a currency crisis? During 1930, 1931 and 1932, deflation was running at about 10% per year, steadily wiping out debtors whose nominal liabilities didn’t change, although their nominal incomes and assets had shrunk by 30% or more.

    Frank Roosevelt’s 40% devaluation of the dollar against gold apparently stopped the deflation in its tracks. In fact, it may have been the SOLE effective policy measure employed, along with many others which backfired.

    Funny, in the histories of the period, the dollar’s massive devaluation is not described as a “currency crisis,” although it certainly was for foreign holders of dollar-denominated assets (a/k/a “beggar thy neighbor”).

    One way to stop real estate deflation in its tracks would be another massive devaluation of the dollar. Lower the dollar index from 78 to 50; crank CPI inflation to 10%; welcome hordes of foreign buyers; and real estate won’t sink much longer.

    Admittedly, the US would be selling its birthright. It would be obliged to forfeit its de facto foreign empire, much as Britain did in the 1940s.

    But all indications are that this is, in fact, the choice our politicians will make. Their planning horizon (by constitutional edict) ranges from 2 to 6 years — the next election. Selling out the country now to get re-elected 3 months hence is an entirely rational policy … from THEIR perspective.

    And speaking as a prospective victim, it’s entirely rational for me and you to do some TWO-FISTED BUYING of the OLD YELLER DAWG.

  11. mxq

    There are several ironies present in this whole cluster****. But one irony that is near and dear to my own heart happens to be the down jones/AIG commodity index.

    I’m just wondering how much of that tax-payer-funded 85 bazillion dollar loan is going to keep that index gig going?

    The fact that the CFTC just admitted they have no clue as to if there are adverse effects of this type of investing, makes this just another fiasco within a fiasco.

  12. Anonymous

    It seems anyone who comes into contact with AIG seems bound to lose their shirts – Eliot, Hank, Henry and now the long-suffering taxpayer.

  13. Anonymous

    “credit analysts are constitutional pessimists”

    hah, glad you’re keeping your sense of humor, that’s what got in this mess right? All those pessimistic credit ratings

  14. Sergei

    BTW, i just found out that the 85bn loan from the government to AIG gives the government ability to veto dividend payments to AIG preferred shares investors. More reason for investors to avoid this type of instrument.

  15. Richard Kline

    So RN, I’m with you: We have to have the re-reg to know what it is that we are re-capitalizing, and what the rules of the game are. As we have seen through the last fourteen months, re-capping the existing big busted players is just pouring liquid treasure into broken crocks. To a degree, we have to during the next six months since Congress and the Administration have wasted their first, best, and only opportunity to get out front of the crash and choose where and how they were going to land. Now, they can only keep pouring and hope that the well doesn’t run dry before we can do the re-reg after the election.

    Them than can plan, do; them that can’t, punt. Given the craptastic proposals for ‘regulation’ Paulson coughed up last Autumn, I’m only too happy to have someone _else_ as point man on the re-build. If we get that far. . . . The Ides of September Massacre grind down, grind on.

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