Crisis Averted, Situation Normal (Not!)30 Sep 2008
The news that the markets have roared back today, erasing many of the record losses of Monday, should make me feel better, but the stock markets are a sideshow – the real action is in the credit markets, and the news there still isn’t good.
Want a quick feel for how bad the credit crisis is? Compare how much banks will accept in interest on Treasury bills (basically a risk-free investment) to what they expect to receive in interest on loans to other banks (there is a non-zero risk that the bank might default, say, declare bankruptcy). In normal times, banks don’t go out of business (very often) so the difference is very small. In exceptional times (like now) nobody knows who is going to be in business tomorrow, and the difference is very large.
Right now, the difference (the “TED spread”) is about 3%, or 10 times the prevailing rate before the crisis began. It is as high as it has ever been, twice as high as it was after the collapse of Bear/Stearns this spring.
Not feeling a lot of comfort right now.