Friday, December 11, 2009

2009 Christmas Card from the U.S. Financial Market

The Bloomberg U.S. Financial Conditions Index provides a daily measure of the relative strength/weakness of the U.S. money, bond and equity markets, and is considered a useful gauge of bank lending conditions and the overall availability of credit. A little more than a year ago in the wake of Lehman's collapse, the financial markets were gripped by fear and panic, and credit risk soared to historic levels (see CD post here on the TED spread). The Bloomberg U.S. Financial Conditions Index plunged from -2.51 in mid-September to -11.3 by October, for an unprecedented five-fold increase in financial market risk within one month (see inverted chart above). U.S. stock prices plunged by more than 25% during that same period, and financial panic started spreading worldwide.

By this time last year, the Bloomberg Index had improved slightly from the October lows, but was still signaling significant trouble in the U.S. money and capital markets, and there was certainly nothing to provide much hope last holiday season. As Scott Grannis reminds us, the world was preparing to celebrate last Christmas and New Year’s in a period of “Great Fear and Trembling."

What a difference a year makes. As we celebrate Christmas and New Year's this year, the U.S. economy and financial markets have staged a remarkable turnaround and the economy has entered a period of gradual, but unmistakable recovery. The inverted Bloomberg Index in the graph above tells the story graphically, and is the "2009 Christmas Card from the U.S. Financial Markets."


At 12/11/2009 4:17 PM, Blogger Smoky Mountain Hiker said...

Mark - I don't dispute the numbers in this trend, or the Ted Spread trend line you posted in an earlier article. However, I keep hearing that banks still aren't lending, and that small businesses are still unable to obtain loans.

These two (seemingly dichotomous) pieces of information just don't compute.

Can you explain? Thanks.


At 12/11/2009 10:47 PM, Blogger bobble said...

smokey, you are correct that banks aren't lending.

my *opinion* is that a good portion of the breathtaking plunge in bank credit is because few businesses are optimistic enough to want to borrow.

At 12/12/2009 6:43 PM, Anonymous morganovich said...


i am hearing the same thing, and i talk to dozens of small companies a week.

here's what i think is happening:

the government is demanding higher tier 1 capital ratios at banks. the banks are happy to oblige at the moment as US bonds count and can easily be levered up 15:1 without causing issues.

so they borrow from the fed at 25bp, and buy 2 years 15:1 at 79bp, which gives you a nice safe 11% return so long as the timing mismatch is OK with you.

arbing this opportunity is why the yield curve is currently do steep and 3 month bills yield so close to 0 that the difference wouldn't get you on the bus. (0.002%, or 2 cents a year per $1000 FWIW)

the banks love it as it makes their ratios look good to the regulators and kicks out a nice safe profit to rebuild their balance sheets.

the government loves it, as it keeps their cost of borrowing low at a time when they are running huge cash deficits.

it all sounds like a virtuous cycle until you realize that it crowds out everyone else. why lend to a risky small business when you can take so much less risk and make the same or better money AND keep your tier 1 high. loans to small businesses are most decidedly NOT tier one capital.

the only reason that this has not utterly frozen the mortgage market as well is that the fed is buying them all. they have bought over a trillion dollars of mortgages and MBS's in the last 12 months.

this program is currently scheduled to end in march. it will be interesting to see if and how they can climb down off that ledge.

At 12/14/2009 10:57 AM, Blogger Methinks said...

this program is currently scheduled to end in march. it will be interesting to see if and how they can climb down off that ledge.

My bet is they'll just extend the ledge and they'll keep extending it until it gets so thin and weak that it'll be too fragile to take apart and too fragile to hold them and the thing will collapse under their feet.


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