Credit Markets Improve, but Interest Rates Still High

Corners of the credit markets are slowly loosening after the government pledged to buy stakes in private banks, but there's still congestion — and investors are also noticing some adverse, unintended consequences from the rescue efforts.

One of them is the yield on long-term Treasurys, used to set the rates on many fixed mortgages. The 10-year Treasury note on Wednesday yielded 3.98 percent, up from 3.45 percent on Oct. 6, the Monday after the government's bailout plan won congressional approval and the start of the Dow Jones industrial average's worst week ever. And according to, the average 30-year fixed mortgage rose to 6.28 percent Wednesday from 5.82 percent last week.

To be sure, there are several positive developments happening in the credit markets. Bank-to-bank lending rates are edging lower. So are rates on the debt known as commercial paper that companies sell for their short-term financing needs, and the spreads on bond default insurance policies known as credit default swaps. Standard & Poor's Ratings Services on Wednesday called the bank bailout plan the "turning point in the crisis of confidence currently afflicting credit markets."

But relatively speaking, rates are still high and lending volumes remain low. And it's becoming clear the price of bailing out the financial system is going to be hitting borrowers for some time.

The government has, among other actions, guaranteed money market fund investments, boosted the insured deposit limit to $250,000, and agreed to buy mortgage-backed securities, commercial paper, and $250 billion worth of bank stock. So now, said Weiss Research real estate and interest rate analyst Mike Larson, bond investors are starting to ask: At what cost?

"The Treasury doesn't have this money sitting in a can somewhere," Larson said. "It will be financed by selling loads of Treasurys."

Nervousness about the short-term outlook for stocks and corporate debt is keeping investors in short-term government debt, or Treasury bills. But worries about the future value of long-term Treasuries after the government finances its various rescue efforts are keeping investors tentative about 10-year and 30-year issues.

"Cheap issues gotten cheaper, and rich issues have gotten richer. That's hurting a lot of people," said John Spinello, bond strategist at Jefferies & Co.

"There's still tremendous demand for Treasury bills, which is not a good thing," Spinello said, pointing to still-weak demand for commercial paper, although those rates are coming down. "Risk taking is at a minimum."

Longer-term Treasurys did see demand bump higher on Wednesday as the stock market tumbled, but not at the same feverish pace that very short-term Treasurys did.

The 30-year bond rose 1 2/32 to 104 22/32 and yielded 4.22 percent, down from 4.26 late Tuesday but up from 4.09 percent on Oct. 6. The 10-year note rose 28/32 to 100 5/32 and yielded 3.98 percent, down from 4.03 late Tuesday but still up from last week. The 2-year note rose 16/32 to 100 26/32 and yielded 1.57 percent, down from 1.82 percent late Tuesday but also up from last week.

Meanwhile, the yield on the three-month Treasury bills, the ultimate safe assets, sank to 0.20 percent from 0.30 percent late Tuesday. That's down from 0.49 percent on Oct. 6. The discount rate was also at 0.20 percent.

Banks are slowly ratcheting down their lending rates to other banks. The London interbank rate, the key rate known as Libor, for three-month dollar loans slipped to 4.55 percent from 4.64 percent on Tuesday. That's down from a recent high of 4.82 percent, but still well above 2.82 percent a month ago.

Libor for overnight dollar loans fell to 2.14 percent from 2.18 percent. That rate has been particularly volatile, peaking on Oct. 1 at 6.88 percent, the highest level since the rate began to be tracked in 2001.

And Libor should continue to fall as the Bank of England, European Central Bank and Swiss National Bank offers an unlimited supply of dollars at fixed interest rates that came in well below Libor in Wednesday's auction, according to Miller Tabak & Co. analyst Tony Crescenzi.

But while Libor is very important — many consumer loan rates are tied to it, including adjustable-rate mortgages — it's not the only factor that goes into pricing and lending standards. The economy is expected to be weak for some time, particularly the job market, which will keep lenders on guard.

"The days of lending to anybody with a pulse? Those days are gone," Larson said.

Banks should have more cash to lend with after the government buys stakes in them.

"It's clear that the government would like us to use the money to make loans," said JPMorgan CEO Jamie Dimon during a call with investors Wednesday. However, he added, "I don't think the government is telling us what to do with the capital."

And even if the government exerts power over how banks use their funds, it's unlikely that they would prod the banks to lend at the same levels they did when the housing market was booming.

Ladenburg Thalmann analyst Richard X. Bove wrote in a note that the U.S. banking system is essentially nationalized now: "The new system will be more regulated ... It will provide much less credit overall," he wrote.