Economaton

AAA banking and finance interest rates are higher than they were a month ago, despite massive interest rate cuts and Bernanke’s bluntly stating his willingness to provide whatever amount of liquidity the banks want. From Bloomberg’s rates and bonds of today, February 17th:

This is not a good sign. I can think of no good reason why interest rates for AAA financial institutions should rise, even as the Fed target and the prime rate have both dropped 50 basis points, but I can think of a few bad ones. LIBOR is down, but hovering above the Fed target. Mortgage rates are similarly up. The interest rate markets seem to be pricing in a considerable risk premium over a month ago for even the highest-rated borrowers. Lack of supply is not an issue with Bernanke orchestrating things, and demand would have to be considerable indeed to drive rates up so much at normal risk premiums.

Caroline Baum points out that rate cuts and monetary easing are not the same thing, and that the monetary base is actually shrinking quite a lot right now. She says that either banks have no capital to loan (presumably because of the massive recent writedowns), or nobody wants to borrow. The former is congruent with very high AAA banking and finance rates; the latter is not. In any case, what changed in the last month? There have been more writedowns, but enough to so drastically alter the market interest rate against the backdrop of an intervening Fed rate cut? Certainly not all banks have had new writedowns. Have those that did lost enough to deplete systemic available capital reserves so significantly?

There are a few possible explanations. One is that there is some looming crisis in the financial industry that the general public doesn’t know about yet. Certainly, nothing substantially new has come to public light in the past month — the MBIA/Ambac bond insurer debacle was old news even then. The other is that this is merely overcompensation for the absurd appetite for risk that fuelled the earlier credit boom, and that the present higher rates are just a panic reaction to that old news. Financial equities have risen slightly in the same timeframe, and overall stock market volatility (as measured by VIX) is down slightly. Still, the disconnect between shares in financial companies and the rates they’re being charged in the wake of considerable monetary easing (or at least, massive rate cuts) is unsettling.

Time will tell, and I’ll be watching these rates carefully to see what happens.

Update, February 29th: Bloomberg has taken note of this issue. They attribute the rise in end-user interest rates to “wariness among lenders and fears of inflation,” as well as inability to securitize loans, meaning that they must be kept on the banks’ balance sheets and thus charged a higher risk premium. Michael Krause suggests that the selloff in Treasury bonds over the past month has increased the rates on other products that are tied to Treasury yields. I think that all of these excellent points, taken together, go a long way towards explaining the situation.