Nothing like a crisis to give you a reason to learn. Today I learned about the TED Spread. This from Wikipedia.
The TED spread is the difference between the interest rates on inter-bank loans and short-term U.S. government debt ("T-bills").
Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three month Eurodollars contract as represented by the London Inter Bank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures, the TED spread is now calculated as the difference between the three-month T-bill interest rate and three-month LIBOR. The TED spread is a measure of liquidity and shows the degree to which banks are willing to lend money to one another.
The TED spread is an indicator of perceived credit risk in the general economy. This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. When the TED spread increases, that is a sign that lenders believe the risk of default on inter-bank loans (also known as counterparty risk) is increasing. Inter-bank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of default is considered to be decreasing, the TED spread decreases.[1]
TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The size of the spread is usually denominated in basis points (bps). For example, if the T-Bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40bps. The TED spread fluctuates over time but is often between 10 and 50 basis points (0.1% and 0.5%). A rising TED spread often foretells a downturn in the U.S. stock market as liquidity is withdrawn.
During 2007, the Subprime mortgage crisis ballooned the TED spread to a region of 150-200bps. On September 17, 2008, the record set after the Black Monday crash of 1987 was broken as the TED spread exceeded 300bps.[2] Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market.[3]
On September 29, 2008, after the bailout bill was unexpectedly voted down, the TED spread achieved a new high of just over 350bps.
I would also note that today as I was eating my chicken ceaser for lunch, everbody at the Hamburger Hamlet in Pasadena had their eyes fixed to CNBC. Sure enough as Bartriromo was interviewing some experts on the floor, they were saying exactly what I've been saying. Don't call it a bailout. It's just the government - somebody with lots of money buying assets at firesale prices because of a liquidity crisis.
The liquidity isn't 'real' but private equity cannot act in unison. Nobody has the time or patience to come up with a private consortium of buyers to shore up that which is weak, even though everybody wants it to happen. So somehow this legislation should include some kind of passthrough facility so that once the feds have stopped the blood loss, private entities can buy up what the Fed purchased.
This is essentially what JPMC and Citibank have done with WaMu and Wachovia - they've eaten about all they can eat.
Now. Understanding that the TED Spread is at some ridiculously gawdawful high number today is the key to understanding why international banks are having trouble even though they are not holders of 'toxic assets'. All highly leveraged debt holding banks are in trouble of getting reasonably cheap cash - and that's why things can grind to a melting halt. The LIBOR is too high.
As an interesting side note, I have the feeling that my company is going to get freaking rich. We happened to be one of the companies that assisted in getting Fannie Mae into the (ahem) 21C - technology wise. I always say that you'd be shocked to find out how many businesses operate their finances on spreadsheets instead of current technology. Those who cannot manage their cashflow are going to be in huge trouble over the coming months. Unless you by our products and services. Yuk Yuk.
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