Financial Markets Unsure If Credit Crunch is Over

Financial markets can’t figure out whether or not the credit crunch is over. Yesterday, with the Fed violently twisting their arms, four major American banks borrowed a total of US$2 billion at the Fed’s discount window and a rate over and above what they could have paid borrowing in the open market. Reading between the lines, we suppose the message was that if these big banks can afford to lose a bit of money borrowing from the Fed, they must have full confidence in both the Fed’s resources and that the credit market is now operating smoothly. But is it?

It depends on who you ask. But what makes this latest version of legendary bubbles so unique is that it’s unfolding in slow-motion. The US$1 trillion or so in adjustable rate subprime mortgages that reset at a higher rate in the next year haven’t been marked to market because…nobody knows if the borrowers who signed those mortgages will be able to pay. They can’t be priced.

That doesn’t mean the bonds which contain those mortgages can’t be rated, especially if you’re a ratings agency and you get paid to rate such things. The mortgage lenders have gotten the worst of the mess so far, going out of business one after the other. But it’s the ratings agencies—Fitch, Moody’s (NYSE:MCO), and Standard and Poor’s—that will be hauled in front of Congress and asked how they rated obviously (in retrospect) risky debt instruments as triple-A credit quality. The answer should be entertaining.

We admit to having a rather uneasy feeling about the current state of play. There is open discussion in the media of bank runs, of the effectiveness of the Fed, of the need for the White House to step in and bail out the borrowers. These are all signs of a highly-stressed financial system, burdened by crippling amounts of debt. Judging by the wave of re-setting ARMs in the pipeline, isn’t there even more stress ahead? And shouldn’t the volatility and anxiety in the credit market favour tangible assets and precious metals?

Writing in yesterday’s London Telegraph, Ambrose Evans-Pritchard says, “The world has changed, dramatically. Whether this means a protracted global downturn and a ‘profits recession’ depends on how quickly the central banks choose to respond, and how far they are willing to go.

“Ben Bernanke is looking hawkish to me, given the shock of what happened on Monday when yields on 3-month US Treasury notes plunged at the fastest pace ever recorded, a panic flight to safety that no living trader had ever seen before. Why? Because trust had collapsed to such a degree that players with a lot of cash no longer believed it safe to leave wealth in bank accounts, or the money market funds of brokerage companies – (exposed as they are to short-term commercial paper and subprime CDOs). This did not occur after 9/11, or in the heat of the October 1987 crash. Nor did was there such a banking panic in October 1929. (it hit in August 1931). If you think this is of no importance, or that this will pass swiftly, you have a strong nerve.”

 “When you have a run on the money markets like this, it is bound to spill over into the real economy,” said Albert Edwards, global strategist at Dresdner Kleinwort.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Coffee Addict
Dan Like you, I have been over thinking some of the issues surrounding the credit crunch. We need to realise that the market is foolishly addicted to hybidised historic cost information. Market values will fall substantially when this years earnings results are tabled. Why would (or should) the US taxpayer bail out foreign financial insitutions such as RAMs Home Loans? Perhaps there was no altenative – but at what cost? Clearly there will be a serious US recession – however there is growth in Asian and European demand and the US export position will be enhanced by a seriously devalued… Read more »
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