By Mark Gilbert
Nov. 29 (Bloomberg) -- An American guy in a string vestbuys a house he can't afford, forcing the Italian government topay more for its money. Chaos theory is spreading the painaround the global financial markets, though stock markets arestill in denial. You know there's a credit crunch. Here's how.
Coordinated Intervention?
The gap between the Federal Reserve's key rate and whatbanks charge each other to borrow dollars for three months haswidened to about 58 basis points, the most in 2 1/2 months. Thecost of overnight money is now more than a quarter-point higherthan the Fed's target. There's a similar picture in borrowingcosts for euros and British pounds.
The European Central Bank said last week there's a ``re-emerging risk of volatility'' and that it will supply cash ``foras long as it is needed.'' This week, the Fed said it would``counter the re-emerging risk of volatility'' in money marketsand will ``provide sufficient reserves to resist upwardpressure'' on borrowing costs around the turn of the year.
You know there's a credit crunch when central banks useidentical words to name their pain.
Yielding to the Inevitable
The 10-year U.S. Treasury yield was whipsawed by 25 basispoints in a single 24-hour period this week. ``That's four timesthe normal daily range over the past decade,'' according toStuart Thomson, who helps oversee $46 billion in bonds atResolution Investment Management Ltd. in Glasgow, Scotland.
The two-year yield dived below 3 percent this week, from 5percent in June. It hasn't been this far below the 10-year levelsince January 2005. Jan Hatzius, chief U.S. economist at GoldmanSachs Group Inc. in New York, this week chopped his mid-2008 Fedrate forecast to 3 percent from 4 percent.
You know there's a credit crunch when the bond market istelling you that the Fed will have to slash its key interestrate from 4.5 percent to avert recession.
Safety First
Investors now demand a 4.44 percent yield to own Italian10-year government debt. That's 38 basis points more than theycharge Germany -- the widest spread since March 2001. The 22-basis-point premium on 10-year Spanish debt versus German bundsis near a six-year high. The story is similar in other Europeandebt markets, including those of France and Greece.
Even though all the bonds are denominated in euros,investors prefer to park their money in German debt. Thosespreads are telling us that there is a flight to quality inEurope as fear trumps greed.
You know there's a credit crunch when governments that havedone nothing to offend the gods of the capital markets areforced to pay more for their money.
The Incredible Shrinking CP Market
Investor appetite for commercial paper is withering away.The total U.S. market has shrunk by almost 17 percent since Julyand is down to $1.8 trillion, the smallest it has been for morethan a year. The amount of asset-backed commercial paper hasfallen to $849 billion, the lowest level since January 2006.
In Europe, the commercial paper market contracted by $23billion last week and has shriveled by $41 billion in November,according to figures compiled by newsletter Capital MarketDaily.
You know there's a credit crunch when short-term cashbecomes unavailable because investors won't lend.
The Profit Engine Is Sputtering
About 90 percent of U.S. companies have now reportedearnings, and ``the news is bad,'' according to Merrill Lynch &Co. The securities firm calculates that third-quarter operatingearnings per share have declined by an average of 8.5 percentcompared with the year-earlier period, the poorest performancesince the final quarter of 2001.
Earnings at financial companies slumped 33 percent.``Financial-related earnings now represent about 30 percent ofthe total profit pie, versus 25 percent just three years ago,''David Rosenberg, Merrill's chief North America economist in NewYork, wrote in a research note. ``It is against this backdropthat we are becoming more certain that the recession is eitherhere or no more than two quarters away.''
You know there's a credit crunch when earnings at a thirdof the economy's companies have shrunk by a third.
Central Bankers Should Keep Mum on Stocks
Bank of England Governor Mervyn King is the quintessentialold-school central banker, hedging his pronouncements with ifsand buts and maybes, highlighting uncertainties and stressingrisks. So his candid comments about stock markets on Nov. 14came as a surprise.
``Equity prices are higher now than they were in August,and in emerging markets they are 20 percent higher,'' he said.``There must be some downside risks. It's that sort of riskthat's the bigger risk to the global economy than the narrowerone from the banking sector.''
You know there's a credit crunch when central bankers startwarning that stock prices are irrationally exuberant.
Neither a Borrower Nor a Lender Be
Paragon Group Cos., the third-biggest U.K. lender to peoplewho buy houses and then rent them out, said last week it mightsell new shares to raise 280 million pounds ($580 million).Paragon, which is down 80 percent this year, can't find a way toreplace a credit line that expires in February.
``The disruption of the capital and banking markets thathas spread from difficulties in the U.S. subprime mortgagemarket has had a significant effect on the cost and availabilityof credit,'' the company said on Nov. 20. ``Since the summer,the securitization markets have effectively been closed to newissuance and, at the same time, banks have become less willingto renew facilities.''
You know there's a credit crunch when a U.K. mortgagecompany with no U.S. mortgages, subprime or otherwise, and noinvestments in structured investment vehicles or collateralizeddebt obligations, can't finance itself.
(Mark Gilbert is a Bloomberg News columnist. The opinionsexpressed are his own.)
