Will Global Quantitative Credit Easing Work?

New fears as credit markets tighten

“The credit markets are seizing up again amid new anxieties about the global financial system.“The fear and uncertainty that sent stocks to 12-year lows is now roiling the market for corporate bonds and loans, which have given back much of the gains they chalked up earlier in the year.

“Short-term credit markets are still performing better than they did last year thanks to government programs to buy commercial paper and guarantee short-term debt. But Libor, the London interbank offered rate, a common benchmark interest rate, has crept up over the past weeks, from 1.1% in mid-January to 1.3% on Friday, reflecting banks' concerns about being paid back for even short-term loans. It is still well below its peak of 4.8% last October.

“This time around, the economy is slipping deeper into a recession, and bond investors worry the government's repeated modifications to its financial-rescue packages are undermining the very foundations of bond investing: the right of creditors to claim their assets first if a borrower defaults. Without this assurance, bonds of even the most stalwart institutions are much riskier to own.

“After what seemed like the beginning of a thawing of debt markets early in the year, sentiment has deteriorated, analysts say. The markets remain open only to the strongest companies. A rally in US Treasury bonds last week reflects another bout of flight-to-quality buying. Junk bonds now yield 19 percentage points more than safe Treasury bonds, up from a 16-point spread in February, according to Merrill Lynch. The spread is still narrower than the 21-percentage-point premium reached last December, but any widening shows investors are becoming more fearful.

“Part of the problem is that investors are still waiting for key details from the government about its plans to bolster US banks and unfreeze the credit markets. After launching a $1 trillion program to kick-start consumer lending last week, the Obama administration is considering creating multiple investment funds to purchase bad loans and other distressed assets. The intent of the funds is to stabilize the prices of good assets and restore investor confidence.

“Without more clarity from the government on its bailout plans, the market could continue to drop, say analysts. That would further harm the economy and the institutions the government hopes to help, compounding its task of shoring up the financial system.”

Source: Wall Street Journal