KEY POINTS:
Not in 70 years or more have the credit markets seen such extraordinary conditions.
Hank Paulson, the US Treasury Secretary, put it most starkly during his testimony on Capitol Hill: "The system is frozen".
The banks will lend to the Government, but not to each other. Put into
figures, perhaps the most telling is the somewhat abstruse spread between the interbank lending rate, Libor, and the overnight index swap rate, effectively the rate for unsecured lending. This spread has become so stretched that it is now a purely notional figure. Banks simply cannot see as far ahead as a mere three-month timeframe.
Take the so-called TED spread, the difference between what the banks pay and what the US Treasury pays to borrow dollars for three months. This has widened to 3 percentage points, from 1.14 points a month ago, and is close to a record high since Bloomberg began compiling this data in 1984. These indices are telling us that any bank going out to raise any medium-to-long-term funding is going to find it tough. Once again, the credit crunch has intensified.
Why? Worries about the Paulson Plan most immediately; worries about the world economy in the medium term, with oddly, to the fore the burden that the Paulson Plan itself will place on the US economy. The Plan promises to take the toxic debts off the banks' books and thus strengthen their balance sheets and transform the credit ratings.
Any signs that a shorter-term positive development is in jeopardy is bound to spook the markets. With the Fed promising to rescue them, there is a chance you would lend to a bank; otherwise you would not.
And as institutional investors make their judgments, retail savers and investors pick up the signals, usually via the share price and negative coverage in the media. If the depositors then start to withdraw funds, then the funding worries, once seemingly remote, become a real, self-fulfilling prophecy. Hence the extreme nervousness.
So what are the banks, and many millions of individuals, doing with their spare funds? First and foremost, the banks are "hoarding liquidity" as they try to repair the damage done to balance sheets over the past year.
They want their investments to be as liquid and as safe as possible, and are lending out funds only to the most secure of institutions or investing in the safest of assets and for the shortest of times; days and weeks rather than months or years. Even commercial paper is doing better, but only at maturities of up to seven days. This time-distortion applies even to such hitherto cast-iron propositions as the Government of the United States of America.
Investors and banks may not fear that America is actually going to go bust and default, but they are not so sure that the vast issuance of debt under the Paulson Plan - US$34 billion (NZD$ 49.80 billion) sold yesterday alone - and deteriorating prospects for the US economy will prevent a run on the dollar itself.
Thus there is a massive preference for short-term Treasury Bills over longer-term Treasury bonds. One-month maturity Treasury Bills are indeed so popular that they have seen their yields fall to 0.1 per cent, against a rate of around 1.5 per cent prevailing a couple of weeks ago.
Even hedge funds have suspended their search for yield in favour of a quest for safety. They have reportedly moved around US$100 billions into "safe havens", simple money-market funds that are traditionally invested in the most conservative of instruments and which are now bolstered by yet another US Treasury guarantee. Gold, the ultimate safe haven, is also experiencing renewed interest.
The anecdotal evidence is that depositors were worried about the money they had in Halifax Bank of Scotland before the Lloyds TSB deal was announced. Northern Rock, now very safe since it was nationalised, has seen an uptick in interest in its products. National Savings too reports more interest.
The banks, it would seem, are waiting for the next domino to fall, not that that will restore confidence. Probably quite the opposite. Confidence has evaporated, and the Paulson Plan is the best hope for restoring it.
Since the credit crunch began, the UK's National Savings and Investments has reported an increased level of interest in their products, which are backed by an unlimited guarantee by the British state. They have said that "it is still far too early for us to see the extent to which the current market instability has affected sales, [but]we have noticed an increase in calls to the call-centre."
Troubles put a shine on gold
Traditionally the safest of safe havens, gold now also has the attraction of being a hedge against a weak dollar. Which could easily arise if the Paulson plan fails, with a renewed crisis in the financial system, or if it succeeds, as the burden of US Treasury debt takes its toll on taxpayers and the wider economy.
So, gold seems a one-way bet. Mark Byrne, director of Gold and Silver Investments, says: "Retail demand is extremely robust as evidenced in shortages of gold and silver in the US, India and in east Asia. The world's largest gold refinery, Rand, in South Africa, was cleared out of their entire inventory of krugerrands in one order by an anonymous Swiss institution."
Goldman Sachs and Citigroup are said to be especially keen goldbugs, as is the Bundesbank, the world's second-largest holder of gold after the US Federal Reserve.
Some say the Chinese Treasury, which has US$1.8 trillion (NZD$2.63 trillion) of US dollar assets and less than 1 per cent of its currency reserves in gold, may warm to the yellow metal.
- INDEPENDENT
