What we experienced in the fall of 2008 was akin to a financial seizure. Liquidity went away in a hurry after the default of Lehman Brothers on September 15, 2008. You could see this seizure very well in two places in the United States financial markets:
- The “TED” spread or Treasury/Eurodollar spread measures the difference between short term bank financing (LIBOR) and short term treasuries (both 3 month)
What the TED spread represented was the perceived credit risk within banks, which could be represented more clearly and on longer tenors by looking at 5 year credit spreads on AA and A banks:
- Banking credit risk blew out to historically radical levels in 2008
The TED spread is not showing any sort of seizure as it did in 2008 and this is due to massive short-term Fed induced liquidity. In the longer-term US banking credit risk spreads, we have seen a widening in those spread levels, but nothing like what we saw post Lehman. In fact, liquidity is currently pretty abundant in the United States.
If we move on to Europe, the risk has been showing up in some sovereign nations such as Portugal, Ireland, Italy, Greece, and Spain (PIIGS) for the last two years. Now the risk has spread back to European banks in their own credit spreads:
- European Financials are trading at their widest spreads
The European central bank and Eurozone members need to take the fear out of bank funding sources within the Eurozone. That fear can lead to deposits and customers fleeing from certain financial institutions just as we saw with Bear Stearns, Merrill Lynch, and Lehman Brothers. The default of a bank such as Societe Generale could spark a very similar forest fire. It seems that Mr. Bernanke might be the only person given enough power and autonomy to provide liquidity through the “central bank liquidity swap lines”. Bernanke can lend out dollars to the ECB and let the ECB lend the dollars to the European banks. Ugly solutions to ugly problems.
