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Fears of Credit Crunch Redux Unfounded

Slumping stocks and soaring Treasury bond prices have stirred memories of the financial crisis, but credit markets are making clear this is not 2008 all over again.

It's no credit crunch: price volatility notwithstanding, funds are flowing between banks, corporations and investors, unlike the funding freeze experienced in the wake of the collapse of Bear Stearns and Lehman Brothers.

"There are a lot of differences between now and 2008," said Scott Macdonald, head credit and economic research at Aladdin Capital.

"If you look at the balance sheets of many corporations, you just have much more cash. Banks, too, have a lot more cash, more liquidity than they did, and they've generally disposed of the worst of the troubled assets."

The difference between the credit crunch that sparked the worst recession since the Great Depression and the current crisis — which is partly about political gridlock — were not so clear when capital markets opened on Monday, after a weekend of mulling Standard & Poor's decision to downgrade the U.S. credit rating.

Initial reactions, exacerbated by growing fears that the U.S. could be headed for another recession, were swift and severe. On Monday, the S&P 500 fell more than 6 percent in the heaviest volume since the flash crash of May 2010, to post its worst day since December 2008, though it recovered most of those losses on Tuesday.

Treasury yields hit all-time lows on Tuesday. Two-year notes traded as low as 0.17 percent, before rising back to around 0.21 percent. The benchmark 10-year note tested its previous low of 2.04 percent, set in December 2008 when the financial crisis was at its height, before ending at 2.28 percent.

Still, the initial shock to the financial system was misleading. Banks have learned lessons from being overextended in the credit crisis and are now better capitalized and more risk averse than they were before.

While their more cautious tack has eaten into earnings, it has also put them in better stead to weather the turmoil. Banks' equity investors might not like the smaller returns on investments, but banks are as liquid as ever — even after S&P's downgrade.

Funds Are Flowing

That's not to say that the world's major economies aren't facing some intractable problems due to weakening growth in demand and deepening debt and deficit problems in the U.S. and Europe.

But the panic has not taken hold of the key credit financing arteries for banks as it did in 2008.

The interest rates that banks and Wall Street pay on overnight loans backed by U.S. Treasurys held steady on Tuesday, signaling money markets are functioning despite turbulence in global stock markets.

In fact, the Fed's decision on Tuesday to specify for the first time that it will keep its target rate for interest rates near zero for at least another two years has had the effect of making interbank and short-term borrowing even cheaper.

Benchmark rates tightened, including swap spreads, a barometer of counterparty risk, which fell by 3.5 basis points after the Fed announcement. Credit indices rebounded on Tuesday after collapsing on Monday.

The tumbling yields on U.S. government debt are a little counterintuitive given the S&P decision, but what the slackening global economy has demonstrated, and what the downgrade has perpetuated, is US Treasurys' entrenched status as the most liquid go-to safe-haven security.

In effect, investors react to a downgrade of U.S. Treasury securities by buying more of the downgraded securities.

Indeed, for some corporations, a risk-averse market is ideal for taking on new expansionary debt. On Tuesday, Thermo Fisher Scientific [TMO 52.04 2.03 (+4.06%) ] showed confidence in the debt capital markets. The technology company hit the bond market with an offering of five- and 10-year notes to fund part of a US$3.5 billion cash acquisition of Phandia.

While the low Treasury yields make it attractive to lock in cheap funding for the company, the timing of the trade was still a surprise given the unstable capital markets. But it reflects another key difference between the U.S. economy now and three years ago. Most economically important companies and banks are better prepared this time around.

The largest US corporations — the same ones that stock market investors pummeled on Monday — have stronger balance sheets than ever.

In the end, Thermo Fisher looks to have timed it right. Just ahead of the Fed's decision it priced a $2.1 billion fundraising at relatively tight rates.

Meanwhile, economic fundamentals haven't changed much since the move by S&P on Friday to downgrade the US sovereign rating one notch to AA+ from Triple A.

The two other major rating agencies, Moody's and Fitch — though concerned over the state of US finances — maintained a Triple A score for the United States, at least for now.

"Is [the downgrade] the end all, be all? No, but it certainly has had an impact," said Aladdin's Macdonald.

Not Out of the Woods Yet

While it's not a liquidity crisis, intractable challenges remain. In fact, because it's a crisis of another ilk, the solution might not be as easy as it was in 2008. The Federal Reserve and U.S. Treasury cannot just introduce more liquidity into the markets to keep things moving as they did to climb out of the last recession.

This time, as the S&P's decision on Friday reflects, a divided Washington that is unable to provide clear leadership is a further burden for a faltering U.S. economy.

Indeed, Tuesday's Fed statement points up the dilemma. After lowering rates to near zero and engaging in two rounds of bond buying, which injected hundreds of billions in new liquidity into the markets, there's not much else the Fed can do towards meeting its twin mandates of maximum employment and price stability.

http://www.cnbc.com/id/44083568

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[kongkiti]

While the low Treasury yields make it attractive to lock in cheap funding for the company, the timing of the trade was still a surprise given the unstable capital markets. But it reflects another key difference between the U.S. economy now and three years ago. Most economically important companies and banks are better prepared this time around.

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