Renewed fears rattle through credit markets

BOYD ERMAN
Tuesday, March 10, 2009
CAPITAL MARKETS REPORTER
Credit markets are lapsing into a renewed slump, stymieing central bankers who have gone to unprecedented lengths to get money flowing into the economy.

After taking some baby steps toward normalcy in the first months of 2009, the market for risky corporate debt such as junk bonds is again seizing up, pushing interest rates higher for those companies lucky enough to find financing and threatening to leave many borrowers shut out. The premium that investors are demanding to buy junk bonds has jumped to 19 percentage points above government bonds from 16 points just three weeks ago.

Investors also fear more financial institutions may fail, sending measures of the risk of bank bonds to record highs. At the same time, the rising cost of interbank lending signals bankers are again growing leery of one another. Banks are now charging 1.31 per cent interest to lend each other U.S. dollars for three months, up from a recent low of 1.09 per cent in mid-January.

About the only debt that investors will buy is the two-year U.S. Treasury, traditionally seen as the safest of all havens.

The flow of money out of risky assets into only the safest exacerbates the economic malaise by making it tough for companies to raise money to expand or even to just stay alive, forcing them to cut jobs and spending to cope.

For Canadian companies that need to refinance debt soon, such as miner Teck Cominco Ltd., the renewed troubles in the credit market are bad news.

"Against a background of worsening fundamentals, a poor fourth-quarter earnings season - thankfully drawing to a close - and the spreading of the crisis's tentacles far, wide and deep, more areas of the credit market are starting to feel the strain," said Suki Mann, a credit strategist at Société Générale in London.

The rapidly worsening recession is one reason for the latest slump in credit markets, with the World Bank yesterday saying that the global economy will shrink in 2009 for the first time since the Second World War.

But analysts say the underlying problem is that while central banks such as the U.S. Federal Reserve are pushing hard to get the economy going again with rate cuts and by printing money, the U.S. government is sabotaging those efforts by failing to lay out a clear and credible plan to deal with problem banks.

"This is really uncharted territory," said Michael Devereux, a University of British Columbia economics professor and a Bank of Canada research fellow. "Most economists would have expected that with this level of expansionary monetary policy and expansionary fiscal policy, we would have started to see some things happen."

The issue for many investors, he said, is "the critical steps to fix the banks have not been taken, and because of that there's just no possibility of a resurgence of financial confidence."

Impatient credit investors panned the announcement yesterday by the Obama administration that Treasury Secretary Tim Geithner will unveil his plans for fixing the banking system in "coming weeks."

"Perhaps the market is pushing, in a free-market manner, the government to make the decisions sooner rather than later," said Tim Backshall, chief strategist at Credit Derivatives Research, a California firm that tracks debt markets.

In the meantime, hard-won gains in confidence from late 2008 and early 2009 are bleeding away.
The Credit Derivatives Research Counterparty Risk Index, a measure of investor fears that banks will fail, rose to a record high yesterday, led by concern that Citigroup Inc. might not make it after posting $28.5-billion (U.S.) of losses since the credit crunch began.

And despite perceptions that Canada's banking system is safer than any, the cost of insuring against a default on five-year debt issued by the country's largest bank, Royal Bank of Canada, also rose to a record yesterday, according to Markit Group Ltd.

That means banks will have to pay more to raise funds, leading to higher rates for borrowers, and many companies that depend on debt will have trouble rolling over loans.

The result is that no matter how much central bankers slash their targets for rates, the economy will struggle until credit markets are fixed because companies will cut jobs, close factories and put off expanding to hang onto what little cash they have.