Getting warmer: Credit markets continue to thaw

More good news on the financial front: credit markets continue to thaw. The three month London interbank offered rate, or Libor, fell four basis points to 79 basis points Monday -- its biggest one-day decline since March 19, Bloomberg News reported.

The Libor has now declined 11 basis points in a week, its largest decline since January. Further, the TED spread, the difference between what banks and the U.S. Treasury pay to borrow for three months, also narrowed one basis point to 66 basis points, its lowest level since August 2007.

The Libor is particularly important because it determines rates on more than $360 trillion of financial products worldwide, from home loans to derivatives. For example, payments on some mortgages that Americans hold are tied to the Libor.

Psychology shift

Joel Naroff, president of Naroff Economic Advisors, told clients he's seeing a shift in psychology as a result of the credit market thawing and related good news on macroeconomic fundamentals, reported Monday. "Worries about a never-ending recession have been replaced by hopes that better times are near," Naroff said.

Through fiscal and monetary policy, the United States has added a record $12.8 trillion in stimulus and liquidity to the financial system and economy, much of which has had the desired effect on the credit markets. That's essential because 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 after 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 have loosened considerably.

Money Trader Jan Misch of at Landesbank Baden-Wuerttemberg in Germany told Bloomberg News Monday that credit market participants are continuing to relax regarding credit flows. "People have become a bit more relaxed now because we haven't had any bad news recently," Misch said.

Monetary Policy/Economic Analysis: Just put the above in the category of another "green shoot." The loosening of credit markets as evidenced by the decline in the Libor and other rates is welcome news. Even so, Libor and related rates must decline more, and credit availability must continue to expand to facilitate commerce. Simultaneously, the U.S., EU, and Japan, along with the IMF, must remain at the ready to intervene if and when a major institution's hiccup interrupts the credit reliquefying process or poses other risks.

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