Finance Weblog: Back on credit issues - Instituto de Empresa Business School

Marzo 06, 2008

Back on credit issues

Juan Toro

The liquidity crisis is back with vengeance. Recent episodes of high LIBOR rates are been resurrected this week and new calls to calm the markets are needed. This increase in risk aversion is taking place almost in any asset, with fixed income assets been those where movement are sharpest.
If we take the case of Europe the level of awareness in happening almost everywhere and even affecting sovereigns (debt issued by governments). Investors have been selling Italian and Greek bonds in signs of panic. This asset reallocation is been recommended from some banks such as BNP or Goldman, leading to spreads of this debt against the German bund of over 52 basis. This spread should be zero because of the European Monetary Union, the existence of a single currency and the sovereign quality of both assets (Greek/Italian debt versus European bonds). People are getting refuge in the classic assets gold or the Swiss franc to name a few. European money markets are on the high again and rates at which Euro zone banks lend to each other has gone over 4.4 %. This implies forty basis point of premium over target despite the efforts from the European Central Bank to grease money markets with floods of liquidity.

In Britain, money markets are also on fire and new actions are expected from the Bank of England (BoE). The Bank of England will probably put aside any moral hazard considerations and will be as aggressive as needed to avoid any new Northern Rock case. There has already been pain in the banks and moral hazard punishments can wait. The Bank of England will probably raise and renew the three months repurchase operations that offered in December. Sterling London interbank rates are at two months high and with similar premium over target as those seen in Europe. Broader collateral in repo operations and an increase of the amount of reserves in its regular repo operations are some of the measures that the BoE is thinking of implementing.

On the other side of the Atlantic things are not very different. We should say they are worse that out here in Europe. Close to the core the heat is higher! LIBOR are high, swap spreads are at record levels (though these days every day a new record figure is set), the cost of insuring corporate debt through credit default swaps is soaring, municipalities are rising money without taking any insurance (who cares about monolines which cannot insurance what they should!) and high yield bonds have risen on average to 7.76 percentage points over Treasury bonds. Not a nice picture. In the meantime there are rumors circulating of explicit government guarantee for Government Sponsored Enterprises (Freddie and Fannie) and Bernanke is asking banks to be lenient with mortgage borrowers.

Central banks And governments are reacting but a lot of bail out is still needed to calm this burning fire.