Encouraging signs in a credit crunch

Better yields on Treasury bills and a lack of 'blowups' recently give investors encouragement.

By Mark Trumbull | Staff writer of The Christian Science Monitor

from the August 27, 2007 edition

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The economy's vital flow of short-term credit hasn't returned to normal, but a transition from fear to hope may be under way among professional investors.

This month a usually boring financial instrument, called commercial paper, has entered a crisis of confidence. A sizable amount of commercial paper represents borrowing by mortgage companies, and some of these debts were suddenly devalued by troubles in the housing industry. Now investors are scrambling to assess whether all mortgage-linked debts are toxic and whether other risks lurk unseen.

That crisis has had a chilling effect on an economy that is already cooling. If corporations have trouble borrowing through the issuance of commercial paper, the ripple effects can encompass everything from the ability of consumers to buy houses or cars to the ability of manufacturers to make big sales.

A key question for the economy is, how soon will short-term credit markets recover a semblance of normalcy?

Economists don't see clear evidence of that happening already, despite the Federal Reserve's effort to calm fears by expanding the flow of credit to banks. But some do see at least some tentative signs that a sense of panic may be on the wane.

"There are clear signs that it's easing. It doesn't mean it's over," says David Wyss, chief economist at Standard & Poor's, the New York credit-rating agency. "What's going on now is a good old-fashioned run on the bank. But in today's world, the bank is the short-term capital market."

Short-term credit provides important lubrication for economic activity. Jeff Werling, a University of Maryland economist, says it's like the circulatory system of the human body, bringing supplies to wherever they're needed.

A manufacturer, for example, will borrow to get materials or to extend credit to a customer. Automotive finance corporations issue commercial paper so that they can make car loans to consumers.

The biggest risk, Mr. Werling says: If the current problems with credit availability persist so long, they could deepen the current housing slump, adding to downward pressure on home prices and stock values. That could affect consumer spending.

He's hopeful it won't come to that. "In a month or so, we'll be past it," he predicts, as long as investors aren't surprised by another major bout of bad news.

Among the encouraging signs as trading drew to a close last week:

•"We've gotten through the end of the week without any serious blowups," says Lou Crandall, an economist at Wrightson ICAP, a firm that tracks short-term money markets. In this case, no news is big news.

•In a bid to ease the crunch, the Fed has lowered the discount rate it charges to banks for short-term credit. And last week it said it would accept asset-backed commercial paper – which has been at the center of the recent storm – as collateral for such loans.

•On Friday afternoon, the yield on three-month Treasury bills jumped to 4.22 percent, up from 3.7 percent earlier in the day, according to the Associated Press. Treasury yields had plunged earlier this month as debt investors fled toward ultrasafe paper issued by the government. The edge back toward normal terrain suggests a calmer attitude about market risks.

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