Record Interest Rate Spreads

Will somebody please tell Chari, Christiano, and Kehoe http://www.minneapolisfed.org/research/WP/WP666.pdf that there is too a credit crunch?

Calculated Risk:

Calculated Risk: Record Spreads between 30 Year Corporate and Treasury Yields: Here is another measure of credit stress... the spread between 30 year Moody's Aaa and Baa rated bonds and the 30 year treasury. The Moody's data is from the St. Louis Fed.... There are periods when the spread increases because of concerns of higher [long-term corporate] default rates (like in the severe recession of the early '80s), but the recent spread is unprecedented.

Comments

[Morgan Price]

Could some of the increase in risk mean that bond buyers no longer trust the ratings agencies? In other words, maybe some of the modern Aaa corporate bonds would have been rated lower during the 1980's recession? Obviously the agency ratings for mortgage-backed securities were totally off; is there any evidence for similar problems with corporate bonds?

[brookside]

A footnote at the very end of the 10/10/08 FRB Release H.8 states "..commercial banks acquired $259.2 billion in assets and liablities of nonbank institutions in the week ending 10/1/08.." I am positive this footnote is referring to the conversion of Goldman Sachs and Morgan Stanley from investment banks to commercial banks on 10/21/08 and 10/22/08. Both Goldman and Morgan setup subsidiary commercial banks in Utah which "bought" the parent's assets and liabilities. CCK did not note or mention this transaction in the their paper and the accompanying graphs. It would seem to me that some adjustments would have to be made to any of the data and graphs that rely on FRB H.8 but that is way above my pay grade.

[Robert Waldmann]

In firefox the graph only goes up to 2005 (I had to go to calculated risk to see the record spreads).

Also what Morgan Price said. I'd guess that part of what is going on is that Moody's has destroyed its reputation forever by rating tranches of tranches of toxic sludge AAA. Result ? A huge transfer from corporations to the Treasury.

Ain't Karma something ?

[Phil P]

Not quite unprecedented. There was you know when.

[Cal]

Can this spread have any meaning when we know that the ratings themselves are deeply flawed, ie can be bought and paid for? What's Aaa? All those mortgage backed securities were Aaa.

[SvN]

Brad, CKM clearly acknowledge this evidence. The second paragraph of the introduction reads

"That the United States is undergoing a financial crisis cannot be disputed. ...spreads on a variety of different types of loans over comparable US Treasury securities have widened dramatically."

[MattYoung]

It is the uncertainty of the political season.

The new leaders are hesitant to give us any specifics which indicate something other than a partial restoration of the old equilibria.

Right now, all we know is that until we get direction, the federal government is going to manage risk across most of the economy. Such a short term insurance policy may help drag things out, but business needs to know the parameters after the insurance program is defunct.

[Sandy]

Portfolio has this interesting article from Michael Lewis: http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom

[sam]

One further point about Chari, Christiano and Kehoe (2008)

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1297337

"Although new lending has fallen, since September 2008, there has been a sharp increase
in commercial and industrial (C&I) loans reported on the balance sheets of U.S. banks. CKK (sic.)
(2008) interpret this as new bank lending; however, our evidence is inconsistent with this view.
Instead, we suggest that the rise in C&I loans on bank balance sheets comes in good measure
from an increase in drawdowns on pre-existing revolving credit facilities (“revolvers”). "

[Barry]

"It is the uncertainty of the political season.

The new leaders are hesitant to give us any specifics which indicate something other than a partial restoration of the old equilibria.

Right now, all we know is that until we get direction, the federal government is going to manage risk across most of the economy. Such a short term insurance policy may help drag things out, but business needs to know the parameters after the insurance program is defunct."

Posted by: MattYoung

Matt, have you noticed the melt-down on Wall St this past year? That ain't normal, even during an election year. Have you also noticed that a whole boatload of allegedly high-quality securities have mysteriously gone belly up? That many financial institutions are clearly more fraud than substance, and are behaving as if they believe that others are at least as bad as themselves?

[Barkley Rosser]

Chari et al do not view risk spreads as any proof of anything. Their line is "the markets are working and the spreads show they are, those spreads allowing all those loans we see in our series." So, one has to supplement all the anecdotal evidence with something else, not just large risk spreads.

Sam provides a partial answer. Howver, I do not see this explaining the crucial numbers on interbank lending, which is largely overnight and which the Chari et al numbers barely show budging, even while we have had gobs of media reports of that market being "frozen," etc.

BTW, another explanation of the broader lending numbers may be the movement of off-balance accounts onto official balance sheets. However, according to Perry Mehrling, the biggest amount of these may have been in Europe where SIVs collapsed, with their remnants coming onto European bank balance sheets. Many of these are now on the Fed's balance sheet as a result of the Fed-ECB swap line arrangement.

[Garett Jones]

As Tabarrok says, there's a credit crunch in prices, but not in quantities.

The weekly St. Louis Fed data (link in URL) shows that in recent weeks bank credit QUANTITIES are still growing faster than in the last recession....

Quantities Quantities Quantities

One tale worth telling:
1. There is a crisis.

2. It will show up in credit.

3. It is not a "credit crisis."

4. It is a zombie crisis.