Credit markets ease only slightly on bailout plans

Posted 09 23 2008 12:45PM

NEW YORK - A few corners of the frozen credit markets thawed a bit Monday on news of the U.S. government's bank bailout plans, but business was hardly back to normal. And, even after the dust settles, credit market participants' lending and borrowing operations are likely to be dramatically changed.

Last week, the credit markets — where the world buys and sells debt — were thrown into a tumult after a cascade of troubling events, from the bankruptcy of Lehman Brothers Holdings Inc. to the bailout of insurer American International Group. Over the weekend, the U.S. government said it would buy $700 billion in mortgage debt and asset-backed commercial paper from the nation's struggling banks.

Although several credit market indicators improved Monday compared to last week, they did not show restored confidence. And they aren't likely to for some time to come, said John Atkins, a fixed-income analyst at research company IDEAGlobal.com.

"For the next five years, certainly, we're going to see a real retrenchment in risk appetite, risk extension," Atkins said.

As investors waited for more information on the bailout plan, they reacted to news that Morgan Stanley and Goldman Sachs were going to become commercial banks, and that Morgan Stanley was selling up to a 20 percent stake to Japan's Mitsubishi UFJ Financial Group Inc. The status of Morgan Stanley and Goldman Sachs as commercial banks regulated by the government could force the two institutions to take on less risk than they did as investment banks.

"We've essentially just eliminated a whole way of doing business," said Howard Simons, strategist with Bianco Research in Chicago, referring to the changes at Morgan Stanley and Goldman Sachs.

That may mean that the level of lending in the credit markets may never get back to its year-ago levels. Over the past year, the asset-backed commercial paper market has shrunk from about $1.2 trillion to a little over $700 billion, according to Federal Reserve data.

To be sure, the commercial paper markets have not completely shut down; UnitedHealth Group Inc., for one, said it was able to successfully sell commercial paper last week. And companies are relying on the market operating in the future; Microsoft Corp. on Monday established a $2 billion commercial paper program.

Still, the market is not functioning normally, which is a worry for corporations — particularly those who issue paper backed by assets such as mortgages.

Simons compared the credit markets' role in the business world to the wiring in a building. You might not usually notice it, but it's essential — and when it turns faulty, it becomes dangerous. "All of a sudden, we're finding out those are causing the building to burn down," he said.

The credit markets are huge and diverse, so they cannot be measured as definitively as the stock market. But there are ways to monitor the willingness to lend in these markets.

One is the 3-month Treasury bill, considered one of the safest short-term investments and an alternative when other short-term debt markets are tight. As oil prices jumped and stocks tumbled on Monday, demand for the 3-month Treasury bill remained high. The yield, which moves opposite from price, was at 0.88 percent by Monday afternoon, down from 0.94 percent late Friday. That means the investment will earn less than 1 percent after three months. The 3-month bill's discount stood at 1.29 percent.

Another indicator is the rate on commercial paper, or the bonds that companies sell to borrow money for a short period of time, usually 30 days. Higher rates mean people are less willing to lend companies money in return for their bonds.

Richard Cantor, chief credit officer at Moody's Investors Service, said during a conference call Monday the ratings agency expects credit conditions to tighten in the near term for individuals and businesses, and that it is "also likely that the commercial paper market will remain challenging" for issuers for some time before returning to normal.

According to Bianco Research's Simons, 30-day dealer commercial paper traded at a rate of 3.2 percent, the same as Friday. That rate is still well above 2.38 percent on Sept. 12, but below the rate of 3.27 percent reached last Wednesday.

The rate for the least risky 30-day asset-backed commercial paper — which tends to be backed by mortgages or credit card debt — was at 3.43 percent on Monday, down from 3.48 percent on Friday but still much higher than 2.6 percent on Sept. 12.

Interbank lending rates also show how loose the lending climate is.

The overnight London Interbank Offered Rate set by British banks, or LIBOR, is the rate at which banks lend to one another. The rate is considered one of the most important rates globally; most U.S. adjustable-rate mortgages are tied to LIBOR.

LIBOR fell to 2.97 percent Monday from 3.25 percent Friday, according to the British Bankers Association. That is down significantly from its peak above 6 percent last week, but it remains high, at nearly 1 percentage point above the U.S. Federal Reserve's target fed funds rate of 2 percent. The target fed funds rate is the rate at which the Fed intends banks to lend to one another.

On Monday, the actual U.S. fed funds rate traded well below 2 percent, a positive sign.

The credit default swaps market also provides insight into the health of the credit markets, by showing how much it costs to insure the default of a certain company's bonds. If the spread — or difference between a certain company's credit default swap rate and a benchmark lending rate — is high, it means people want a high return on their investment because they believe the company is more likely to default.

A broad credit default swap market indicator, the Markit CDX North America Investment Grade Index, was at 1.45 percent above LIBOR, down from 1.51 percent above the LIBOR on Friday, according to Phoenix Partners Group. The credit default swap rates of Morgan Stanley and Goldman Sachs were also lower on Monday than on Friday.

Few market experts are calling an end to the turbulence. Atkins of IDEAGlobal.com pointed out that the trouble in the credit markets "has taken place without the onset of what the bond market fears most: A default cycle."

Corporate bond defaults are historically low right now. However, that could change if the economy weakens further, which could send the credit markets back into turmoil and investors flocking to Treasurys.

On Monday, the 10-year Treasury note fell 2/32 to 101 8/32, with a yield of 3.85 percent, up from 3.81 percent late Friday, according to BGCantor Market Data.

The 2-year Treasury note rose 1/32 to 100 12/32, with a yield of 2.17 percent, down from 2.18 percent. The 30-year Treasury bond slipped 19/32 to 101 10/32, and yielded 4.42 percent, up from 4.41 percent.

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AP Business Writer Tom Murphy in Indianapolis contributed to this report.