Tuesday, October 21, 2008

The paradox: Interbank credit showed only minimal signs of stress

Yesterday, 10/20/08, credit markets breathed a big sigh of relief, but U.S. interbank lending never froze up - at least in the data. I will let John Jansen at Across the Curve explain the financial indicators:
”Prices or Treasury coupon securities posted bifurcated results today as the return to normalcy continued with a vengeance. I have chronicled in other postings the improvement in the corporate bond market as well as in mortgages and agencies. The price action in the Treasury market echoes those results. One bill trader with whom I just spoke made the comment that the market is “doing the thing that hurts the most people. In his market that means higher bill rates. Three month bill and six month bill rates climbed over 30 basis points today and everyone is now a seller….

The yield on the benchmark 2 year note jumped 10 basis points to 1.71 percent. Other benchmark securities experienced declining yields. The yield on the 5 year note slipped 2 basis points to 2.81 percent. The yield on the benchmark 10 year note declined 7 basis points to 3.86 percent and the yield on the 30 year bond decreased 7 basis points to 4.25 percent.

The 2year /10 year spread is about 215 basis points after trading as wide as 240 basis points last week.

The 2year/5year/30 year butterfly moved to 33 basis points from 27 basis points Friday. That indicates the richening of the 5 year note against the wings of the butterfly.

The significant flattening of the yield curve and the decline and fall of the 2 year note reflects participants shifting views that tr
ades premised on a view that financial Armageddon is nigh now lack profit potential. The entire student body is racing to the other side of the bus."
Point: Bond market jargon with the following point: Generally, credit conditions are improving. Two illustrations of credit markets conditions (click on graph to enlarge):

andBut what I am wondering is: Did interbank lending show the stress implied by the financial indicators? According to the Fed's data, not really.

The chart illustrates weekly growth in commercial interbank lending in the U.S. over the year. I expected lending to show significant signs of stress - given the recent banking crisis - where the series would generally decline since September (money markets froze the week ending 9/19/08).

However, interbank lending only declined for two weeks (so far, the last data point is 10/8). Interbank lending declined sharply in the week ending 9/24/08 and falling further the week ending 10/1/08. This correlates with high stress in the banking system when the House voted down the first draft of TARP.

But interbank lending recovered precipitously in the week ending 10/8/08. If anything, I would describe interbank lending as only slightly stressed during the heat of the crisis. This is truly amazing, given the sharp increase in bank reserves (see chart from last week's post).

The financial indicators are coming back in line with interbank loan data that never showed the extreme duress implied by the credit markets – only for two weeks did the loan data start to trend downward. I conclude that the biggest credit problems was not present in the interbank lending market (at least in this U.S. data), but with lending outside of the banking system: the money market and all loans tied to the Libor rate.

Rebecca Wilder


  1. And, if you compare with 7/2-7/11, the decline is much the same as 9/24-10/8. The whole "crisis" is not across the board as certain cities, like Denver, have not had much of a problem with housing sales (as an example). A shotgun approach is not as good as a rifle in many cases. Thanks for finding the interbank lending facts.

  2. Might want to take a gander at the emac blog on foxbusiness.com - Report the SEC Doesn't Want You to See - WOW