Ben Bernanke’s Credit Easing — Mortgage Rates at Historic Lows, but the Credit Crunch Continues
In his address at the 2009 Credit Markets Symposium in Charlotte, North Carolina, Federal Reserve Chairman Ben Bernanke said on Friday, April 3 that the Federal Reserve has been pursuing a strategy of credit easing to address the current crisis involving a severe disruption of credit markets and declines in asset prices.
He said, “As best we can tell, so far the programs are having the intended effect.” He cited a drop in the 30-year fixed mortgage rates as an example. It is true that the 30-year fixed mortgage rates have dropped dramatically to historically low levels. But, can the same success be seen in other metrics signifying the credit crunch? Has the credit crunch ended already? Are the banks lending like before?
The TED and The LIBOR-OIS spreads are the commonly used metrics to test credit easing or lack of it. In an earlier post here, I had gone into the definitions and characteristics of the two metrics. In a nutshell, increasing TED and LIBOR-OIS spreads indicate that the banks are concerned about a higher risk of default on their loans.
TED Spread
The figure below shows TED spread for the five-year period ending on April 3, 2009. It ended the day with a value of about 94 basis points from a peak of 464 basis points on October 10, 2008. However, it trended much lower pre-credit crisis and averaged 36 basis points in 2006.
Source: http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND
LIBOR-OIS Spread
The figure below shows LIBOR-OIS spread for the five-year period ending on April 3, 2009. It is around 100 basis points, about the same value it had shot up to in August/September 2007 at the onset of the credit crisis. However, it is down from its peak value of over 350 basis points in October last year. Historically, it was of the order of 10 basis points.
Source: http://www.bloomberg.com/apps/cbuilder?ticker1=.LOIS3%3AIND
Both the TED and the LIBOR-OIS spreads indicate considerable easing of the credit crunch from its worst. However, the data indicate that the credit crunch is still alive and kicking. Former Federal Reserve Chairman Alan Greenspan said in June, 2008 that the LIBOR-OIS spread would have to fall to 25 basis points for him to consider markets back to “normal.”
Banks still consider lending riskier, and are, therefore, not lending like before. Historically low mortgage rates are welcome in that many existing homeowners might be able to refinance their mortgages to put a little extra cash in their pockets.
However, in the face of increasing unemployment, foreclosures, and a lack of consumer confidence, low mortgage rates alone are unlikely to spur a housing boom. That will happen only when businesses encompassing all parts of the economy begin to move forward in tandem unfettered by credit crunch. The economic engine cannot move forward efficiently until all the moving parts of the economic engine get a liberal dosage of its lubricant – credit.
Until the two spreads come down to their historic pre-credit crisis values, it would be wrong to assert that the credit crisis has eased. What do you think?
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