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Winter Thaw?
By: Dr. Charles Lieberman
Date: 12/22/2008
Considerable progress was made last week in thawing the credit markets, although more work remains to be done. Once risk spreads decline closer to normal levels, companies will be able to obtain routine financing and the risk of corporate failures will recede. Moreover, once credit becomes available in business markets, such as for asset backed securities, credit availability will improve for consumers.
The frozen credit markets thawed noticeably. Mortgage rates declined significantly, corporate bonds spreads declined and several companies issued new bonds. Commercial paper outstanding is rising, while risk spreads declined for A2/P2-rated nonfinancial companies. Improvement was seen in the financing activities of General Growth Properties, a company that acquired several companies largely with short-term loans that needed to be rolled over. When the credit markets froze, it was threatened with a cash crunch and a potential bankruptcy. So it was a great relief to its shareholders and investors generally that the company managed to roll over nearly $1 billion in debt. It is important to establish that heavily indebted companies with good assets can obtain fresh financing when they need face routine maturing obligations.
Conventional 30-year fixed rate mortgages fell below 5%, setting off a surge in refinancing and exceeding the capacity of bankers to process the new applications Since interest rates are likely to remain low for some months, bankers and borrowers will have plenty of time to adjust. Just as importantly, low mortgage rates may also lift housing purchases and rid the system of the inventory overhang. Inventories should decline because of strong demand, not just reduced new construction.
The thawing of the credit markets will tend to build on itself. As conditions improve in some markets, capital will tend to flow into other frozen markets that offer more attractive terms. So a significant improvement in the residential mortgage market should spill over in the commercial mortgage market. These prospects should be greatly reinforced, once the Fed starts buying significant quantities of mortgage and other securities over the coming weeks.
A weak first quarter for the economy is already baked into the cake. However, if credit markets thaw and housing bottoms in the spring, as I expect, then conditions will allow an economic recovery to begin in the second quarter, somewhat sooner than generally expected.
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