There is no doubt that the credit problems in the financial markets are in a critical phase. Today, the London Interbank Offered Rate (LIBOR), which measures the interest rate by which banks will loan unsecured cash to each other in the London money market (one of the largest in the world, and a closely watched barometer of credit availability in the world), has just exploded in the upward direction, more than doubling from Monday to Tuesday.
LIBOR has more than doubled overnight.
What this means is the following:
Commercial banks have grown increasingly reluctant to provide each other with short-term loans, partly out of fear of further bank failures and concerns about the health of their own balance sheets.
The overnight London interbank offered rate, or Libor, registered a record one-day increase, reaching 6.875% from 2.56875% on Monday, according to news reports. Libor rates for sterling and euro loans also rose.
It also means that the credit crisis is well and truly a crisis that stretches far beyond our shores. The flood of toxic sludge from reckless securitization threatens the worldwide banking system. When the interest rate for interbank funds lending exceeds the average rate charged for a 30-year consumer mortgage, you have to suspect that even the biggest banks are going to become isolated islands in the credit market, and that it will become even more difficult for businesses and individuals to conduct even routine credit-based transactions in the broader economy.
This will have significant effects on interest rates in the US. Mortgage rates and rates for any kind of loan will increase further, regardless of the string-pushing Fed.
One cannot say enough about the absolute fiscal and policy recklessness that led us to this point. It is not just the Congressional Republicans and George Bush - it goes deeper than that. Alan Greenspan deserves the lion's share of credit for creating an excessively permissive credit environment over the last ten years. By persistently encouraging the housing bubble through artificially low interest rates, that policy fed into the virtually unregulated home financing market, whose boom was further fed by a huge wave of securitization of mortgage loans spreading throughout the economies of the West, which in turn were encouraged by a wave of deregulation starting with the repeal of Glass-Steagall through the Gramm-Leach-Bliley Act of 1999 and the lamentable failure of credit-rating agencies to do their job.
It was a huge cycle of recklessness for which the Republicans may be about to pay a huge price, and deservedly, at the polls in November.
We should be so lucky.
Anything to prevent a recession - literally ANYTHING. Greenspan, and Bernanke also, both attempted to forestall the business cycle by inflating one bubble after another.
Bailout schmailout. I doubt $700B would touch the credit market. The central banks of Europe and in the U.S. have persistently injected liquidity into the credit markets for many months now. The LIBOR and Ted spreads have fluctuated up and down during this time, but now the crisis is reaching a tripping point. One way or another, the credit markets WILL find an objective interest rate level that reflects reality.
IN the early 1980's as I recall, short-term interest rates reached over 20%. We may be in for a similar episode, even if the eventual rates are not as drastic.
Oh and let's not forget - debt that any corporation takes on for investments of any kind just took a huge jump upwards in interest rates. This means a potential big slowdown in corporate spending on all kinds of equipment, hiring, and pretty much everything else they do that requires money. H/t to 924birdhouse for flagging this point.
***Edit***Even states in this country, such as Massachusetts, are having trouble getting capital to meet expenses. From Beachmom below:
Unknown terrain for economy
In an example of how fragile credit markets have become, the state of Massachusetts yesterday tried to borrow $400 million to make its routine quarterly local aid payments to cities and towns. State treasury officials said the credit markets abruptly froze midday, leaving them $170 million short. The state will have to use its own funds to complete the local aid payments, draining the state's balance to extremely low levels.
"I don't think any treasurer alive could say they've ever seen anything like this," said Timothy P. Cahill, the state's treasurer. "There have always been cash shortages, but you could always go to the market and get more. This is the first time we haven't been able to do that."
Cahill said he believes the credit market will in effect remain shuttered today as the nation's largest lenders hold on to their cash amid uncertainty over plans for a federal bailout. In short, the House's rejection of a $700 billion Wall Street bailout plan takes Massachusetts and the rest of the US economy into territory that few policy makers and analysts wanted to explore.
...
The federal bailout proposal called for the government to spend up to $700 billion to buy mortgage-based securities and other holdings from financial firms. The idea is to boost confidence in those companies by taking the troubled investments, whose values have been sapped by the subprime mortgage market meltdown, off their books. Banks and other financial firms have stopped lending money to one another, afraid that their counterparts may have large holdings of such mortgage-backed assets, and could be in the same danger that caused firms such as Lehman Brothers to file for bankruptcy.
"These markets have to be stabilized somehow, " said Eugene White, economics professor at Rutgers University. "If we get into a downward spiral of credit tightening, more people will lose jobs, they'll stop buying goods and services, and we're in a recession that will be hard to get out of."
White said the collapse of the financial system and the subsequent drying up of credit created such a spiral in the early 1930s, turning the economic downturn into the Great Depression. He said the House's failure to act could be compared to the Fed of that period, which largely stood on the sidelines during a wave of bank failures. "We need government to come in and take decisive action," White said.
The era of easy money is at a permanent end. I refuse to use the word meltdown. This is a situation that has been brewing for years and was masked by the exploding real estate markets in America and many European countries. This is necessary and has to happen in order for the markets to return to long-term rationality.
Many intelligent suggestions have been given on this site so I will not repeat them. I only hope that a more rational "rescue" plan, reflecting the need to put a floor under the housing market in the form of direct help to distressed homeowners, becomes the primary thrust of a second bill. This would have the effect of shifting the demand curve in the housing market by preventing even greater numbers of homes from hitting the market. Meanwhile, housing prices continue to decline in many metropolitan areas in the U.S..
If the Congressional Dems persist in their compulsive concessions to a rump Republican minority, no bailout bill will succeed in addressing the problem.