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Lending Rates Increase

By Deidre Shirley

Bank-to-bank lending rates increased Tuesday, September 30th 2008, and Treasury bill demand remained high, a day after Congress' rejection of the huge bank bailout plan cast an even deeper freeze over the barely operational credit markets. After the House's vote against the Bush administration's plan, investors pulled their money out of stocks and commodities Monday, sending the Dow down nearly 780 points and crude down more than $10 a barrel (well, one good thing is that should help out gas prices). That money got moved intoTreasury bills, short-term debt issued by the U.S. government that's considered the safest investment around, low risk = low reward though, and investors are unlikely to keep their money in something like Treasury bills for too long.

On Tuesday, the yield on the 3-month Treasury bill recovered to 0.62% from 0.14% late Monday as the Dow Jones industrial average rebounded by more than 230 points in midmorning trading, making some investors and middle-class Americans believe the economy can fix itself without government socialist take-overs. The Treasury bill yield is still very low by historical measures, however -- particularly when compared to lending rates between financial institutions, which are increasing. Banks were in misery modes after the House's rejection of the rescue package: the key bank-to-bank lending rate, the London Interbank Offered Rate, or LIBOR, soared to 4.05% from 3.88% for 3-month dollar loans, and to 6.88% for overnight dollar loans. The higher the bank-to-bank rates, the higher the rate you'll get when you try to apply for a credit card or any other type of loan. Central banks around the world have been increasing their lending in an effort to keep the markets functional.

On Monday, the Federal Reserve said it was doubling the total amount of cash loans to banks to $300 billion, and making $620 billion available to other central banks through other currency swap arrangements, up from the original $290 billion. Those efforts, however, have done little to encourage lending from bank-to-consumer.

"There's so much liquidity in the system -- unfortunately, the liquidity is not opening up lenders at all,"

said Mr. Kim Rupert, the managing director of global fixed income analysis at Action Economics.

"It's the epitome of credit turmoil. There's too much fear in the market. Everybody is hoarding their cash, hoarding their reserves, not trading funds with each other."

For big companies to operate and grow, they need to borrow money. Typically, they do this by selling short-term and long-term bonds in the credit markets. Right now, the short-term debt markets are at a standstill; the long-term debt markets are a bit more functional, but rates are very high and risky. Companies in search of cash do have an alternative -- they can go directly to the bank. But banks have their own problems with capital right now, so a company trying to get a loan has about as much luck as a person trying to get a mortgage, you'll need perfect credit and a high percentage down payment. Those with clean credit histories will likely get loans, but at abnormally high rates. Those with poor credit histories might not get loans at all. "In a good case scenario, the economy is slow. In a bad case scenario, there are massive bankruptcies," said Mr. Axel Merk, portfolio manager at Merk Funds.

"The problem is, the general public doesn't understand this. Maybe we need to see a few payrolls fail at a few companies before they realize," Merk said.

"This has a very direct impact on Main Street."

After shooting up on Monday longer-term Treasury prices pulled back, pushing yields still higher. The 2-year note fell 8/32 to 100 16/32, and its yield rose to 1.75% from 2.13%. The 10-year note fell 23/32 to 102 25/32 and yielded 3.66%, up from 3.58%. The 30-year note fell 1 8/32 to 105 15/32, and its average yield rose to 4.17% from 4.12%. Seems like small numbers, but these can mean millions in our economy.

Published: Tuesday 30th of September 2008 11:19:59 AM

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