History points to worst of the crisis being over

John Parry - Reuters

Those on Wall Street who point to history as their best guide are breathing a little easier as early signs emerge of a thaw in credit markets frozen by the biggest financial crisis this generation has known.

In the past week, there have been tentative signs that credit conditions are easing - albeit with the help of colossal injections of liquidity from central banks - and that is starting to conform to the pattern of crises in the past half century, where interbank lending rates tended to reach extremes about two months after a major financial shock.

Libor, the London interbank offered rate, which is the leading global benchmark from which short-term borrowing costs are set, will keep falling from its most extreme levels seen last week, broadly replicating patterns seen during previous periods of market turmoil, said Tony Crescenzi, chief bond market strategist with Miller, Tabak in New York.

The three-month dollar-Libor rate has fallen for seven consecutive sessions and was fixed at 3.83 percent Tuesday.

Even so, that is still about 2.3 percentage points above the target short-term rate set by the U.S. Federal Reserve. The spread is extremely wide by historical standards, suggesting that some banks are still hoarding cash as they wait to see how the crisis unfolds.

''It tends to take about two or three months for investors to begin to overcome financial shocks,'' as was the case in 1987 after the stock market crash, and in 1998 after the Russian debt default and the fall of the hedge fund Long Term Capital Management, Crescenzi said.

In retrospect, the nadir of the global financial crisis could prove to have been in early to mid-September, when the U.S. government seized control of the mortgage finance giants Fannie Mae and Freddie Mac, and when Lehman Brothers filed for bankruptcy, according to some analysts.

''We are already entering the second month now and entering that timeframe when significant progress is starting to occur and being sped up by substantial government action,'' Crescenzi said.

If the fears of market participants continue to fade, an important signal to watch for is whether three-month Libor rate falls near 3.5 percent, Crescenzi said. That should be accompanied by substantial improvements in sentiment in both the stock market and the investment-grade bond market, he added.

Another sign that investors are recovering a little composure and venturing cautiously into riskier assets is the rebound of rates on very short-dated U.S. Treasury bills, as flows start to go into interbank lending markets and more risky assets like stocks.

''Signs are emerging that the credit crisis is in the early stages of easing,'' Tom Sowanick, chief investment officer at Clearbrook Financial in Princeton, New Jersey, wrote in a note.

The recent steep rise in Treasury bill rates toward the 1.5 percent Fed funds target is another sign that money markets are normalizing, Sowanick said. The three-month T-bill rate jumped to 1.2 percent Monday, the highest level in a month and up from 0.81 percent late Friday.

Still, there is a significant camp of fund managers and analysts who remain concerned that the panic of 2008 will deliver more unpleasant surprises.

No one is convinced that the crisis will be truly over until the huge amount of support from the central banks and governments is actually removed from the market and banks can lend to each other without help, a development that could take a long time.

Before financial markets can start to trade with any semblance of normality, analysts said, banks must lend to each other and to companies, whose plight in the 15-month-old credit crunch now threatens to tip the world into recession.

''We do have to get back from total unwillingness to lend,'' said Jay Mueller, senior portfolio manager with Wells Capital Management in Milwaukee. ''We are probably talking about weeks or months to get markets functioning well on the credit side.''