KEY POINTS:
While equity markets continue to behave as erratically as a three-year-old on a sugar high, there is a slightly more reassuring picture of the credit crunch emerging.
Take a look at the graph above. It is nicknamed the Ted Spread and charts the difference between the interest rate the US Government is charging for cash (three-month Treasury yields) and the rate the banks are charging each other.
What it provides is a graphic illustration of why media commentary on the crisis from mid-September to mid-October was so apocalyptic ... and why it isn't (or shouldn't be) now.
For several years the credit spread had tracked along at a stable, historically low, level - less than 1 per cent. As the chart shows, things started to go haywire early last year as the US sub-prime mortgage crisis started to unfold. In August last year credit concerns accelerated suddenly when investment bank BNP Paribas froze funds. At that point the Ted Spread spiked above 1 per cent for the first time in a decade.
It is fair to say the credit crunch was upon us from then. Credit was suddenly a lot more costly and credit markets were far more volatile.
It was also clear from that point that some economic fallout was inevitable. However there was a great deal of hope that the worst of the crisis would be confined to the US.
That situation changed in September this year when Lehman Bros collapsed. The anxiety in the credit market turned to outright panic. The Ted Spread exploded. When it went through 3 per cent above the three-month Treasury yield it exceeded levels last seen in the crash of 1987.
Suddenly the old reference points for analysts were out the window as the spread kept rising.
Part of the problem was that interbank lending froze almost completely. It was in that period that a number of banks in the US and Europe started to collapse, prompting the first of many multibillion-dollar state bailouts. In fact liquidity got so low that it exaggerated the Ted Spread, which blew out to 4.65 per cent - a level never seen before. At that peak, on October 10, nobody knew what would happen next. Financial institutions were collapsing at an alarming rate. The threat of a global financial meltdown was very real.
But it didn't happen. The leaders of the G7 nations met and vowed to act en masse. On Saturday, October 11 the Weekend Herald ran the headline "Crisis meeting to save the world". And that is pretty much what happened. The next few days saw Governments around the world pledge trillions in bailouts and banking guarantees. And credit markets recovered - albeit tentatively.
Make no mistake, we are still in the credit crunch. Lending rates have not returned to normal - they have returned to levels that were already considered extremely worrying for the first half of the year. There is still some risk of an unforeseen shock spooking the already fragile lenders and blowing the Ted Spread out again. But the prospect of financial Armageddon has receded greatly.
What we are seeing now is the real economy reacting to the aftermath. Touch wood. The economic fallout is more painful in many respects because it is manifested in the form of rising unemployment as companies scale back on growth. But it is also more predictable.
The lousy economic data coming out of the US is still causing big slumps on Wall St. But the news itself isn't really surprising. Or at least it isn't as surprising as big investment banks admitting they are bankrupt.
The biggest legacy that the spike of September and October 2008 has left us with may in fact be the psychological trauma. In a few short days it turned the thinking of the world upside down. The damage has been done. But even though there are signs of a recovery more work is needed before we can feel confident the crisis is history. In the last few days the easing of Ted Spread has paused.
But hopefully world leaders at the G20 meeting in Washington this weekend will restore some more confidence and the slow healing process will continue.
* Liam Dann is the Herald's business editor.
