Hell may yet freeze over again in a second wave of the global credit crisis.
Despite some evidence of a bank lending thaw, some analysts worry that the fragile recovery in credit markets is based almost entirely on gargantuan central bank liquidity programs and government bailouts which have yet to be funded via debt markets.
“The short-term fix has been to throw more money at the problem,” said Jes Black, an analyst and fund manager with NetBlack Capital, a New York-based currency fund. “But we haven’t really addressed the fundamental factors that got us here,” namely excessive borrowing, Black said.
For now, trillions of dollars of government cash have cranked opened the taps for desperate borrowers of all stripes who spent the final quarter of 2008 parched for credit. Libor rates, or the London interbank borrowing rate which is the benchmark for trillions of dollars of short term loans to consumers and businesses, have fallen steeply in recent months.
This week, the ‘Ted Spread’, which measures the premium banks charge for three-month dollar Libor over ultra-safe US Treasury bill yields, dipped below 100 basis points for the first time since just before investment bank Lehman Brothers went bankrupt, signaling the extreme panic in these markets is ebbing, for now.
But the worsening financial position of several big US banks, including Bank of America and Citigroup, this week has helped stall Libor’s decline. Some analysts warn that fear may hit new extremes in a second round of the global financial crisis as the costs of government bailing outs send bond yields spiking, crippling the global economy and contributing to yet more failures of banks and companies.
“This is a temporary respite and when it’s over, the stock market will make new lows, and Libor spreads will go beyond their extremes in October,” says Robert Prechter, CEO at research company Elliott Wave International in Gainesville, Georgia.
Attempts to support an economy that’s already borrowed to the hilt by issuing more debt are often destined to fail, says Prechter, whose book ‘Conquer the Crash’, published in 2002, warned of the dangers of the US debt bubble and a deflationary depression, advising investors to shelter in cash. In 2008, investors took huge losses as stocks, commodities and corporate bond prices plunged. Cash and government backed Treasuries, especially T-bills, were the safest place to hide.
England in the 1720s, when the so-called South Sea Bubble collapsed stock prices, offers a salutary example of what is happening to the global economy now, Prechter says. “People were trying to solve the problem by offering more credit and that didn’t work,” he said. “That is what is happening in the banking system today.”
American borrowers became “completely maxed out” in the 2002-2007 period and “no amount of additional credit will be able to change the direction of deflation,” Prechter said. The US government is expected to issue some $2 trillion of debt this year, flooding the $5.8 trillion Treasury market, analysts expect, while the total bill for promised government rescues and aid to the financial system could run to $8 trillion.
Yet some more bullish analysts draw some comfort over the near term from signs that massive amounts of central bank cash are enabling companies, homeowners and consumers to borrow again, if they want to. Rates on three-month US Treasury bills, have edged up to 11 basis points from zero in mid-December when panicked investors fled to the comparative safety of ultra short-dated government paper.
“Ever since the Fed has said we will give you whatever you need, there has been a steady drop in the Libor rate,” said Tony Crescenzi, chief bond market strategist with Miller, Tabak & Co. in New York. A key catalyst was the Fed’s announcement in November that it would buy agency mortgage-backed securities, he says. Since November, US investment grade and high-yield bond prices have charted a spectacular rally.
But the government’s purchases of battered assets merely delay the day of reckoning for the banking system and the economy, some say. “We haven’t worked off the excesses that led us to the crash,” says Black. If job losses continue to rise, causing consumers to cut back spending even more, eroding companies profits and undercutting stocks and corporate bond prices, investors could dump these assets again with a vengeance. “In every indicator that I follow, the bear market is not over yet,” says Prechter. (Reuters)