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15 Aug 2022 3:20
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  •   Home > News > Business > Features

    When will the crisis end?

    How will we know when the credit crisis is over? Every day there seems to be a new disaster, with billions of dollars being written off, finance companies failing, banks under pressure and now a jump in mortgagee sales.

    Investment Research Group
    Investment Research Group
    US commentator John Mauldin believes one indicator that the credit crisis is starting to improve is when the gap between low risk and higher risk fixed interest products return to their usual levels.

    Government stock is seen as 'risk free' because a government can almost always tax enough to meet its obligations. Therefore, all other fixed interest products trade at a premium to this rate because they are riskier.

    The 'spread' between what they are offering relative to government stock is a good measure of how nervous investors are. Borrowing costs for businesses have risen on average to around 390 bps - around 500% higher than in the past.

    Utilities, which you would think would be somewhat immune to the economic crisis and the recession, have seen their borrowing costs rise by almost 300%.

    "And if you have to go into the high-yield market, which is now once again referred to as the junk bond market, you have really been hit. Your spreads, on average, have risen from 240 bps to over 860 bps in the last year.

    “That means IF (and that is a Big IF) you can find someone to loan you money, you will likely be paying an interest rate close to 13% for your money.”

    He also looks at what banks are charging each other to lend money. This is measured by LIBOR (the London Inter Bank Offer Rate).

    "Banks in the US are going to need to roll over almost US$800 billion dollars in medium-term debt in the next 16 months. Banks borrowed heavily in 2006, a lot of it in 2-3 year floating-rate notes, and now they must refinance those notes.”

    Say a bank borrowed at LIBOR plus 50bps. In today's environment, many banks are not going to be able to borrow at such low rates, Mauldin says. He says regional banks will have to pay spreads of 7% - 9%, based on the price of their debt today.

    "If you have to pay 12% to borrow money when prime is at 5% and you are lending at 6% - 8%, you clearly cannot make a profit. That means they will have to sell assets or raise very expensive equity capital.

    "There are a lot of small and regional banks that are in trouble. Banks can get into trouble rather quickly if they cannot raise capital, sell assets, or borrow money due to perceived distress."

    He points out that such banks will have less money to lend and will be calling in loans from otherwise good customers, which of course makes the economic situation even worse.
    That's the situation in the US. Unfortunately, it is not alone. The UK's central banker Alistair Darling, has just stated he believes Britain is facing "arguably the worst" economic downturn in 60 years which will be "more profound and long-lasting" than people had expected.

    The comments caused an uproar and Darling has since been trying to soften his comment, but many see it as a rare moment of candour from someone who should know what he is talking about.

    Meanwhile, in this part of the world, the spread over the risk free rate has risen from a historical average of 14 basis points to100 basis points. This is a strong indicator that, no, the credit crisis is not yet over and tough times remain.

    © 2022 David McEwen, NZCity

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