The Credit Crunch is Beginning to Unclench

(MoneyWatch)  Housing sales are still awful, the stock market remains volatile, and the unemployment rate continues to rise. But there's one very important glimmer of hope: the government has successfully managed to unfreeze parts of the U.S. credit market, which had seized up almost completely after the once-unthinkable collapse of Lehman Brothers last September made banks afraid to lend to almost anyone at all.

Take one key measure of credit-market liquidity, the London interbank offered rate, or Libor. That's the interest rate big banks charge each other for short-term, dollar-denominated loans. Virtually all loans in the U.S. market, from car loans to mortgages, are tied to some extent to the Libor rate.

When the credit markets froze up last fall, the Libor rate soared to 4.82 percent, up from the 2.5 percent level where it had hovered for most of the summer -- a clear indication that banks were afraid to lend money even to each other. The Libor rate has been highly volatile since the start of 2009, but is now down to a much more reasonable 1.19 percent.

In another key indicator of a loosening market, the TED spread -- the difference between Libor and the interest rate paid on three-month U.S. Treasuries -- is currently hovering at about one point, down considerably from its high of 4.6 points last Oct. 10. That's still higher than the spread was a year ago, but the drop is still good news, as it indicates that investors are increasingly comfortable with riskier investments -- risky, that is, compared to government bonds. In turn, that speeds the growth of credit, which spurs investment and economic growth.

What's Worked
Federal Reserve Chairman Ben Bernanke has claimed credit for the reduction in key interest rates, and he's justified in doing so. Over the last few months, the Fed and the Treasury have thrown trillions of dollars at the problem via a number of lending programs designed to help thaw the credit markets and get banks lending again.

One of the more effective programs came last month, when the Fed announced it would buy $300 billion of Treasury bonds and $750 billion of mortgage-backed securities in a bid to drive down interest rates. Rates on 30-year fixed mortgages almost immediately fell to 4.85 percent, their lowest level in 37 years, according to Freddie Mac. The Mortgage Bankers Association said home refinancing applications surged 30 percent in one week as consumers sought to lower their monthly mortgage bills.

The Fed also recently rolled out a program known as the Term Asset-Backed Securities Loan Facility, or TALF, pledging to buy $1 trillion worth of securities such as bundled loans for cars, credit cards, and tuition payments. So far, the government's plan to prime the pump has gotten off to a slow start, as investors such as hedge funds have only requested $4.7 billion of loans out of the $200 billion available, but it's still early.

Other significant moves by the Fed have included easing the market for commercial paper, an important form of short-term lending that allows large companies to pay for daily expenses like rent and payrolls, and helping to stabilize the corporate bond market. J.P. Morgan, Pfizer, and Swiss drugmaker Roche have all been able to sell billions worth of bonds recently. That one-two punch makes it much easier for firms to keep up a normal flow of goods and services.

Where We Go From Here
Longer term, the key test for such programs will come in the bond market. If major banks and corporations continue to issue bonds with ease, and if bond interest rates continue to decline relative to those on Treasury bills, then the credit crunch may be effectively over -- at least for now. We're not out of the woods yet; credit spreads remain volatile, and in fact spiked up again as recently as early March before settling back down. Still, broader trend suggests that many parts of the credit market are starting to return to life -- good news for an economy that depends heavily on credit for its growth.

Melting ice image via Flickr user Marc from Borft, CC 2.0