Credit Markets Finding New Life

High-level signs indicate that a slight recovery may be underway in the credit markets.  Experts hope that this is the start of a broader mending in business and consumer credit, as well as in mortgage lending.

Spring is just around the corner, but U.S. economists aren't watching the hillsides for early wildflower blooms. They'd rather keep their eyes glued to bond activity, mortgage rates, and LIBOR rates to see if the latest signs of life in the credit markets are going to blossom into a larger economic recovery.

Credit markets warming up

No one's ready to say a recovery is in the making, but improved activity in the credit markets is raising some eyebrows. On the corporate side, high-grade companies are being welcomed to the bond market by return-hungry investors; Bloomberg reported $41 billion in corporate bond sales for the week of January 9, the highest weekly total since last spring. On the banking side, interbank loans have become strikingly less expensive as the LIBOR has fallen from 4.8 percent in October to just below 1 percent. And on the consumer side, national mortgage rates dropped below 5 percent, from nearly 6.5 percent in August.

Bank, corporate, and taxpayer bailouts

These improvements follow several months of intense action by the federal government to get the economy moving again. Multi-billion dollar programs funneled money into banks and automakers. Corporate debt issues were guaranteed. To drive down mortgage rates and jumpstart mortgage lending, the Federal Reserve made plans to buy toxic mortgage-related assets. And taxpayers have been benefactors too; the FDIC increased its deposit insurance coverage and rolled out a money market fund guarantee program. A taxpayer bailout may be included in Obama's new stimulus package, as well.

Loss of faith

The credit markets had been progressively less welcoming since the subprime crisis blew up in 2007. But things really went sour when Lehman Brothers, a respected, established financial services company, declared bankruptcy. That event created big losses for the many financial, corporate, and municipal entities that had loaned Lehman money. Worse though was the psychological impact: Lehman's bankruptcy, along with the string of bank failures and other bad news, cemented the idea that it simply wasn't safe to lend money.

That extreme risk phobia hit corporate lenders immediately. When corporations can't get financing, they have to lay off employees, cancel expansion plans, and cut back on benefits. When that happens, consumers spend less money, which eats away at the profits of retailers and consumer credit card issuers. More layoffs follow, businesses start shutting down, and unemployed borrowers can't keep up with their mortgage and consumer credit payments. Indeed, the most frightening aspect of a problem in the credit markets is how quickly that problem can spread to other economic sectors.

The recent improvement in credit activity represents a large ray of economic sunshine. After all, when things are getting better, it means that they're definitely not getting worse.