Why we’re not heading for another GFC

At the height of the GFC I introduced you to what is called the TED Spread, which is the difference between the rates paid by the US Treasury and the rate that banks charge one another in relation to interbank loans.

In other words, it is an indication of the risk that banks attach to lending to one another. The higher the spread, the less confidence there is in the security of the loan. The higher the interest rate, the greater the perceived risk. 

Well, in the GFC the rate went through the roof because banks simply did not trust one another. Every bank was wondering what hand grenades all the others were hiding in their vaults. Confidence went out of the lending market and the rates soared. This is a graph of what happened:

As a result, financial markets choked and without the massive trillions of dollars bailouts around the world and huge stimulus money, financial Armageddon threatened. Gradually, TED came back into traditional waters and things seemed as though we were getting back on track. Suddenly, everyone became aware that Greece was a country and that its government and a lot of businesses in Greece had borrowed a lot of money in a corrupt environment and that money has disappeared into a black hole.

The lenders have come knocking on the door but there is no money in the money box to repay the loans and everyone is running scared. Now, it is not that Greece will go bankrupt (which is more than likely) but that the banks that lent the money, (here we go again with the commissions paid to those pin striped suited guys who are supposed to measure risk), are facing haircuts and those haircuts are going to get right down to the skin if a few more sovereign states go belly up such as Portugal, Spain and Ireland.

Now, you can imagine in the heyday of lending how all these bankers were going around assuring lenders that the loans were safe “For heaven’s sake, we are lending to sovereign states such as Greece and Portugal; they can’t go broke”. (It is amazing, because in the South American crisis of the last century, all the loans to corrupt South American dictatorships were on the same basis “Countries can’t go bankrupt”. Will we ever learn?). Anyway, the proverbial has hit the fan and banks are running scared so what has happened to the TED spread. This is today’s graph courtesy of Bloomberg:

Yes, it has gone up sharply in recent days from a relatively normal situation but nothing like its performance during the GFC. So, the question everyone is asking is: “will it go higher?’

In the GFC we were talking about trillions of dollars at risk in economies such as America. Germany, France, Japan and England. We are now talking about hundreds of billions in relation to countries whose economies are not driving the world economy. I don’t know anything about economics but I can’t believe we are talking about the catastrophe that threatened in the GFC. However, until either a credible bailout that doesn’t result in social disintegration is arranged or bankruptcy follows, TED is going to be nervous, banks are going to be nervous and lending is going to be more difficult.

Historically, after every major upturn in the TED spread, there has been a resurgence in the stock market that tumbles as the TED spread increases. As the TED spread eases, markets rebound.

We are in for a wild ride and some economic commentators think that things could get terrible. I suppose here in Australia, we were spared the consequences of bank corruption and things certainly did get terrible in the US and Europe with high unemployment but the world did not come to an end. In the GFC, the major world economies were at risk. Today, these economies are coming out of the woodwork and companies (as well as banks) are in far greater shape today than they were at the height of the GFC.

I feel that the TED spread would have to go up much more dramatically for a serious crisis to take hold of the world economy.

At some point in time between now and when TED gets back to normal there must be some good buying opportunities. Stay tuned or just watch the daily movement of the TED spread here.

Louis Coutts is a Research Fellow at Thunderbird School of Global Management in Phoenix Arizona. He is currently writing a book on the enduring principles of management.