Tuesday, 21 October 2008

Short View: Is it safe to go back in the water?

Short View: Is it safe to go back in the water?

By John Authers

Published: October 20 2008 20:58 | Last updated: October 20 2008 20:58

Credit Default Swaps (from here on CDS, the cost to ensure debt default) on the world's major banks have gotten cheaper. That means that investors believe the likelihood of a major bank collapse has decreased. Sounds like stability. Markets believe things are moving in the right direction but the CDS are still much more expensive than they were before the implosion of Lehman Brothers.

In even more positive news for finance, the interest rate at which banks lend money to one another overnight has dropped from 5.37 to 1.5. This indicates an increase in trust between institutions--they are more willing to lend to one another. Note: this market is very important for the banking industry because it is what allows the banks to meet their balance sheet obligations without having to liquefy assets etc... However the rate at which banks are willing to lend to one another over a three month period is still far above historical levels. This indicates a fear of instability in the coming months.

All this seems like good news for the capitalists. Although, the CDS and interbank lending rates do not reflect only internal market conditions, so a strong argument can be made that the loosening of lending and the cheapening of insurance are reflections of the government's guarantees and not the health of the system.

And, finally, money markets, now flooded with cash, are experiencing a continuation of a flight to safety. This phenomenon is marked by high demand for Treasury Bills (considered to be the safest investment because the U.S. government isn't likely to collapse any time soon) and the subsequent decrease in their yield (the interest that they pay) to 0.06 percent.

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