Credit market far from tossing away its crutches

CHICAGO (Reuters) - New Federal Reserve liquidity measures announced on Wednesday continue the process of healing for severely injured global credit markets, but a happier day will be when the market can toss away its crutches for good.

The positive reception to moves by the Fed, ECB and Swiss National Bank in currency, equities, and credit markets was short-lived in Wednesday trading, underlining how brittle the financial system remains.

“This latest I.V. keeps the patient in stable but not critical condition, but not ready for discharge,” said Doug Roberts, chief investment strategist at Channel Capital Research in Shrewsbury, New Jersey.

By various measures the credit crisis of the past year is still raging, or in the Fed’s words, conditions remain unusual, exigent and fragile.

The U.S. central bank said it would continue to lend directly to investment banks by extending the Primary Dealer Credit Facility (PDCF) and the Term Securities Lending Facility (TSLF) from the originally-planned August sunset.

The Fed also announced a new program, auctions on TSLF options, for times of “elevated stress” such as the end of a quarter.

“These actions should help to somewhat alleviate market stresses, but are incremental rather than transformational,” said economists at Goldman Sachs.

The PDCF gives investment banks access to the Fed’s discount window for lender-of-last-resort cash. The TSLF is a series of weekly auctions of 28-day loans of Treasury securities to primary dealers.

An extension of the facilities was hinted at recently by Fed Chairman Ben Bernanke and other Fed policy-makers.

Still, it was seen as well timed ahead of major economic reports due later this week and the Federal Open Market Committee’s policy meeting next Tuesday.

“It should be a plus for depository institutions and financial institutions in general,” said Michael Moran, chief economist at Daiwa Securities American in New York.

A trader works on the floor of the New York Stock Exchange January 22, 2008. REUTERS/Brendan McDermid

The lending facilities could be around until at least the end of January, or withdrawn if circumstances change.

“The Fed was clear that these facilities (PDCF and TSLF) are temporary and will end when it judges the emergency has passed,” said Marc Chandler, currency strategist at Brown Brothers Harriman in New York.

Measures such as the TED spread, the difference between Treasury bill yields and Eurodollar deposit yields, still imply high risk in the banking system.

“Some reduction of uncertainty in the banking sector is a prerequisite, but right now it seems another shoe is falling every other day,” said Channel Capital’s Roberts. The sector could take years to fully right itself, he added.

The TED spread, which was trading near 25 basis points before the credit crisis erupted in August 2007, peaked in March near 200 bps, but is still near 100 bps.

“Conditions in financial markets remain very fragile, with key gauges of the health of the financial sector only looking moderately better than the most recent peak in the spring,” said Rudy Narvas, analyst at 4CAST Ltd in New York.


A “show me” attitude prevailed in the credit default swap market, which measures the cost of protecting corporate debt.

The main index of investment-grade credit default swaps traded down to about 130.5 basis points early but ended at about 132 bps against 131.6 bps at Tuesday’s close, according to Markit Intraday data.

“There’s still a lot of serious issues out there that need to be resolved and more bonds that need to be marked down across the financial spectrum,” said Mirko Mikelic, a corporate bond portfolio manager for Fifth Third Asset Management in Grand Rapids, Michigan.


Analysts said the Fed’s provisions can’t address the issues behind the credit crisis, now nearing a dubious first birthday, namely the billions of dollars in bad mortgages that have sunk the U.S. housing market and caused more than $400 billion of writedowns at financial institutions around the world.

Figures on Wednesday showed that serious delinquencies on loans guaranteed by Fannie Mae FNM.N, the largest provider of funding for U.S. residential mortgages, rose to 1.3 percent in May from 1.22 percent in April.

With U.S. house prices still plummeting, according to the latest Standard & Poors/Case Shiller home price index, mortgage delinquencies most likely have not peaked.

In a report this week, economists at Deutsche Bank forecast that the shock from the credit crunch and the related reduction in leverage ratios at financial institutions would linger.

“We estimate that this deleveraging will depress credit supply to the non-bank sector by roughly 15 percent in the United States and 12 percent in Euroland by 2010,” the report said. “The current credit tightening has the potential to be a significant drag on growth for some time to come.”

In that vein, GMAC and Ford Motor Credit on Tuesday announced steps to cut back on auto leases, a move that threatened to hurt auto sales already at decade lows.

“Creditors in the United States are wary of making mortgage loans, consumer loans, and student loans, all of which are rising in price and have become less available,” said Timothy Canova, professor of international economic law at Chapman University School of Law in Orange, California.

“There is no forcing banks to take on increased risk at a time when their losses are mounting,” he said.

Additional reporting by Dena Aubin in New York