Why the panic? The Lender's Fear Meter

Credit markets are frozen and now going into deep freeze mode if something doesn't change quickly. A deep freeze in credit markets would not only be lethal to individuals trying to finance purchases like cars and homes but the problem also effects many large and small businesses who need cashflow to buy things like equipment, pay payrolls, finance receivables, etc.

One of the best ways to gauge credit problems in the market is the TED Spread which is a credit spread. The TED Spread is calculated as the difference between the 3 month T Bill interest rate and the 3 month LIBOR.

LIBOR is a daily rate based on average interest rates that major banks lend (unsecured) to each other.

The dollar-denominated overnight LIBOR soared to 6.88% on 9/30/08, from 2.56%, its highest level since records began 24 years ago. The LIBOR rate is tied to many revolving credit lines including credit cards, home equity loans, and adjustable mortgages. This will further the pain in the housing market via adjustable rate mortgages adjusting at higher rates and credit in general costing more for individuals and businesses to tap credit lines. Banks are also unwilling to lend to each other because they don't trust what other banks will do with the money that they lend, they think other banks might be insolvent and unable to repay loans.

In short, the easiest way to think of the TED Spread is to use it as a lender's "Trust Meter". When the meter is at low numbers trust flows throughout the banking system, banks make loans to each other and to customers such as businesses and individuals and the economy hums along. When the TED spikes the opposite happens. Right now the TED spread stands at 3.61!!!! This is higher than the 1987 stock market tankage, the height of the 1st gulf war and the coinciding housing issues around '91, and the giant LTCM hedge fund collapse.


sources:

http://www.bloomberg.com/apps/quote?ticker=.TEDSP%3AIND