Ray of light: Credit markets continue to thaw

Here's one ray of light for investors: credit markets continue to thaw.

The London interbank offered rate, or Libor, is dropping at the fastest pace since January, as financial institutions worldwide gain confidence that the worst of the financial crisis is over, and that Fed / Treasury and companion major economy actions are working, Bloomberg News reported Tuesday.

The Libor fell to 1.12 percent on Tuesday, from 1.32 percent a month ago. The Libor is particularly important because it determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. For example, payments on some mortgages Americans hold are tied to the Libor.

Padhraic Garvey, ING rate strategist, told the London TimesOnlineTuesday that he likes the trend.

"Libor rates are managing to drift lower in a sustainable manner," Garvey said. "While we are not suggesting the crisis is over with conviction, there is clear evidence of a coincident thaw."

Bernanke sees credit progress

Fed Chairman Ben Bernanke, in a Tuesday speech, said he sees progress on both the credit market and macroeconomic fronts.

"A leveling out of economic activity is the first step toward recovery. To be sure, we will not have a sustainable recovery without a stabilization of our financial system and credit markets," Bernanke said. "We are making progress on that front as well, and the Federal Reserve is committed to working to restore financial stability as a necessary step toward full economic recovery."

Bernanke added, "We face no problems that cannot be overcome with insight, patience, and persistence."

Credit markets: Lifeblood of economy

Credit markets comprise the lifeblood of the economy. Businesses large and small access short-term credit to meet payrolls, pay suppliers, and access cash for other short-term needs. Banks also lend to one another to meet short-term cash needs. A market-based economy can not operate at its growth potential without liquid, functioning credit markets, most economists agree. When credit markets contracted severely in September 2008 when Lehman Brothers collapsed, it set in motion a chain reaction of reduced borrowing and investing that hurt commercial demand. Economies slowed around the globe, and large layoffs of more than 500,000 jobs per month in the United States soon followed.

But now, after several months of the use of a series of term auction facilities by the U.S. Federal Reserve, and the U.S. Treasury's plan to remove toxic assets from the banking system, credit markets are loosening. In a Tuesday speech, President Obama said his administration's policy are starting to turn the tide regard the availability of credit and economic growth, but cautioned that much more work lies ahead.

"From where we stand, for the very first time, we are beginning to see glimmers of hope," Obama told Reuters Tuesday.

Ira Jersey, head of U.S. interest rate strategy at RBC Capital Markets in New York, echoed President Obama's view that the change in the credit markets is palpable.

"Not so long ago the main worry was whether the bank you're dealing with was going to be around in three months time," Jersey told Bloomberg News Tuesday. "Now that concern is on the back burner. We're going to see Libor coming down steadily."

Monetary Policy / Economic Analysis: To cite a phrase popularized by Fed Chair Bernanke, we are beginning to see "green shoots" in the economy, and the loosening of credit markets as evidenced by the decline in the Libor and other rates is welcome news. But let's be clear: the credit cure will not occur a week, nor in a month, nor in a quarter. Monetary-based liquidity injections must be continual, with proactive measures, and the U.S., E.U., and Japan, along with the IMF must remain at-the-ready to intervene if and when a major institution's hic-cup poses systemic risk. In other words, the credit and macroeconomic recoveries will be slow and incremental as the U.S. and the world slowly but surely neutralizes the impact of the worst financial crisis since the Great Depression.
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