- The Washington Times - Wednesday, May 6, 2009

The freeze in credit markets that threatened to take down the world economy last fall has thawed considerably this spring.

By hurling trillions of dollars at the problem, the Federal Reserve and U.S. government clearly have had an impact. But the Fed remains worried that continuing tight credit conditions and potential reversals in the financial markets could doom a recovery that it hopes will begin later this year.

Progress in unfreezing the credit markets has been unmistakable. For the first time ever, the London Interbank Offered Rate (LIBOR) for three-month dollar loans between banks fell below 1 percent Tuesday, the British Bankers’ Association reported. LIBOR was above 1.3 percent in early March.

LIBOR is a benchmark interest rate that affects more than $350 trillion in loans, including U.S. adjustable-rate mortgages. LIBOR peaked at 4.82 percent in October as credit markets across the globe threatened to collapse in the wake of the September bankruptcy of Lehman Brothers, the Wall Street investment bank.

The current LIBOR premium relative to the Fed’s targeted overnight interest rate is still nearly four times higher than it was before the credit crisis began.

Also, the so-called TED spread, which measures the percentage-point difference between the three-month LIBOR and three-month Treasury bills, fell below 0.8 Tuesday after peaking at 4.63 in October. While this decline represents progress, the TED spread averaged only 0.5 before the credit crisis erupted in August 2007.

The LIBOR-Overnight Indexed Swap spread measures the willingness of banks to make loans to each other for longer periods. From a peak of 3.65 percentage points in October, when banks were extremely reluctant to lend to each other because they worried about the borrower’s solvency, the three-month LIBOR-OIS spread dipped below 0.8 Tuesday. As encouraging as that sounds, the LIBOR-OIS spread averaged 0.1 before the credit crisis began.

The improving trend in interbank lending rates and spreads suggests “some further easing in bank balance sheet pressures as bank lending continues its recent sharply contracting trend,” said Ted Wieseman, an economist at Morgan Stanley.

“The Fed believes that a relapse in financial-market conditions remains a significant risk to the incipient recovery,” said Brian Bethune, chief U.S. financial economist for IHS Global Insight.

“Conditions in a number of financial markets have improved in recent weeks,” Fed Chairman Benjamin S. Bernanke told the Joint Economic Committee on Tuesday. “However, financial markets and financial institutions remain under considerable stress, and cumulative declines in asset prices, tight credit conditions and high levels of risk aversion continue to weigh on the economy.”

While mortgage rates have fallen sharply since last fall, Mr. Bernanke acknowledged that “the supply of mortgage credit is still relatively tight.” Mr. Bernanke also noted that “mortgage activity remains heavily dependent on the support of government programs or the government-sponsored enterprises.”

The Fed’s April survey of senior loan officers, released Monday, revealed that about 50 percent of domestic loan officers “indicated they had tightened their lending standards on prime mortgages over the previous three months.” About 65 percent of the banks that still issued nontraditional mortgages had tightened their standards.

Banks have been tightening credit standards for commercial and industrial loans to large- and middle-market firms for more than two years. But the Fed’s April survey also revealed that 37 of the 38 domestic banks that saw weaker demand for commercial and industrial loans indicated that “a decrease in their customers’ needs to finance investment in plant and equipment was an important reason for the change in loan demand.”

Indeed, business investment spending during the first quarter plunged at a 38 percent annual rate, by far the steepest quarterly descent during the 62 years that the Commerce Department has compiled quarterly data.

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