Bizhack.net

Is this week’s rally in the stock markets a signal that asset managers are dipping in and calling the bottom? If poor results, albeit better than rumoured, lead the banks’ share prices to jump, are traders applauding the banks cleaning out their write down closets or is this the continuing last hurrah of the bull market?

Merrill, JPMorgan and Citi (not forgetting GE’s shocking results) maintain that everything is going to be ok, but let’s actually take a look at the money rather than the talk.

There are multiple ways in which one can measure the markets’ perception of banks creditworthiness and we’ll take a brief look at the simplest and clearest of them.

Firstly, the London Interbank market via the British Bankers Association (BBA) decides LIBOR (London Inter Bank Offer Rate) fixing rates on a daily basis, these are then used to price a huge number of more complex instruments. These LIBOR rates should reflect the levels at which banks lend to each other. We can see quite clearly that not only are these rates on the rise again, but also that the differential between LIBOR and the actual base target rate set by the Federal Reserve is rising too. This rising differential indicates the lack of trust between banks that has been so talked about in the press, as we can see that they can borrow from the Federal Reserve at cheaper rates, but are not willing to reflect this lower rate when lending to each other because there are still fears concerning remaining holdings of toxic waste, ahem, I mean CDOs of ABS and sub-prime loans.

All this doesn’t even take into account recent developments that the BBA has issued a directive warning that it will expel any banks believed to be manipulating the fixing rate they contribute to the LIBOR calculation (it’s averaged between participating banks).

So, it looks like the chronic issues of trust between banks are still haunting the market, and all that toxic waste continues to be downgraded in creditworthiness by the rating agencies. The key concern that is keeping all those central bankers and government policy makers in a sweat is the extent to which these issues will have an impact on the everyday consumer.

Last week Max Power already outlined the extent to which banks are pulling out of the mortgage market and that this will lead to decreasing house prices, but banks are tightening credit conditions all round: personal loans and credit cards as well. The danger is that this decrease in our ability to spend feeds through to lower consumption across the economy and therefore a recession. Could be a self-fulfilling prophecy, although recent muted measures by the Bank of England (following the lead of the Fed) to inject more liquidity into the system by allowing banks to borrow more easily could prevent a more protracted problem.

Are we near the end then? That will be determined by those institutions at the centre of our modern economy – the banks. Until then, the advice for you: batten down the hatches and reign in your spending. Credit will still be available for those businesses with solid plans and good prospects, and rightly so as lending to finance investment is crucial to the economy’s continuing dynamism. However, going into debt for consumptive purposes, no matter how much you want that 42” LCD TV, is a dangerous move in any financial climate, let alone this one.