Posted on 09/30/2008 1:36:27 PM PDT by politicket
I had mentioned in a previous post that you need to be watching the ‘flow of money’ rather than the stock market. As you can see today, there are a number of investors that are gambling that this whole ‘crisis’ was a hoax and that they stand to make a whole lot of money by getting in at market bottom. But what does the money movement say?
I’m going to teach you a very easy way to know if liquidity in our market is expanding or drying up. In other words, is the circulatory system of our economy healthy? Or in danger of failing?
This can be measured fairly well by using what is known as the ‘TED Spread’. It stands for ‘US Treasury – Euro Dollar’. The US Treasury part of the equation derives from the interest rate on 3-month Treasury Bills, while the Euro Dollar part comes from 3-month LIBOR (London Inter Bank Offered Rate) which is the interest rates that banks charge each other for loans.
As an economy starts to turn sour you see massive amounts of investors ‘flee’ to 3-month US Treasury Bills because of their extremely low risk factor. An increase in the purchase of T-Bills will drive the interest that they pay lower, since the T-bills have strong desire amongst investors, and high interest rates are not needed to attract buyers.
Inversely, a sour economy will tend to drive the LIBOR rate up since this rate measures the risk of lending money to commercial banks. As times become more uncertain, banks hoard their money and won’t lend it to each other because they don’t trust that they’ll be paid back. This drives the LIBOR rate up.
So, in effect, taking the difference between the 3-month LIBOR rate and 3-month US Treasury interest rate will show the credit risk in our economy.
In a great economy, investors are wading into the stock market and have very little use for 3-month T-bills. They’re willing to take more risk. Therefore, less demand for T-bills will drive the interest rate that they pay up so that they can attract buyers. Likewise, 3-month LIBOR will drop because banks don’t have any anxiety that their interbank loans will default because money is moving freely in the economy. The difference between the two rates (the TED Spread) will range between 0.10 and 0.50 (each ‘tenth’ is known as a ‘basis point’ – so it ranges between 10 and 50 ‘basis points’).
In a bad economy, investors are seeking shelter for their money, so they flee to US Treasury bills. This greatly increases demand for the bills, so the interest rate that they pay drops – because they do not have to offer much to attract investors. The LIBOR rate in a bad economy will rise because money is not flowing as freely and banks are scared that the loans they make to other banks won’t be paid back – so they raise the interest rate to cover the risk. The difference between the two rates (the TED Spread) will increase as a result, and be a higher number of ‘basis points’.
When the housing bubble popped in July 2007, the Subprime mortgage problem surfaced. Basically, the cash flow from the mortgages was not enough to service the underlying bonds – causing the bonds to default – and causing the associated Contract Derivative Swaps to trigger – causing the ‘insurers’ on the CDS contracts to owe a whole lot of money that they did not have.
The TED Spread during the latter part of 2007 increased to a range of 150 – 200 basis points and our economy struggled. Remember the basis points should be as low as possible – preferably around 15 – 20 basis points.
Now that you hopefully understand the TED spread, you can look at it on each market day to get a ‘gauge’ of how our economy is doing. It’s not the only indicator, but it’s a good one for the novice investor.
Let’s now calculate the ‘TED Spread’ for right now as I type this, to see how our economy is doing. The stock market today is telling us that things may not be as bad as they seem, OR the stock market is telling us that there are a lot of gamblers out there placing their bets without understanding our economic structure.
First, we need to find the interest rate on 3-month US Treasury bills. Easy enough. Go to Bloomberg.com to find out, or just use this link - http://www.bloomberg.com/markets/rates/index.html.
Look for the ‘3-month’ line under the US Treasuries section. You can then look under ‘Current Price/Yield’. We want the ‘yield’, so it would be the number following the ‘/’. It is currently showing 0.73 as I type this.
Now, we need the 3-month LIBOR rate. Again, go to Bloomberg.com, or follow this link - http://www.bloomberg.com/markets/rates/keyrates.html.
Look for the 3-month LIBOR column under the Key Rates section. The Current rate is showing 4.05 as I type.
Now we do some simple math: (3-month LIBOR) – (3-month US Treasury bill interest) = 4.05 – 0.73 = 3.32 = 332 basis points.
What is 332 basis points telling us? It is saying that the stock market is full of gamblers today and our economy is in very, very bad shape.
So, who the hell are you?
If I wanted to make that case to the sheeple, I would lead every newscast with individual case stories of; successful businessmen who can't get credit, homebuyers with good incomes and down payments who can't get a mortgage, and runs on commercial banks with strong balance sheets.
I'll be looking for those stories this week.
I call BS
Thank goodness Paulson and Bernanke warned us at that time that the economy needed help.
Anyone less ethical would have just spread the news around with their insider friends and not come to Congress and the public until the last possible second.
I'm Politicket - and who they hell are you?
You’ll know when your checks start bouncing.
Might be time to see what your bank’s exposure to Freddie and Fannie is.
Triple Dog Dare Dead Cat Bounce.
Euros running from their own meltdown looking for cover.
Interesting post although the T-bill yield is now at .89 and last year the LIBOR was over 5.
place mark. When is part 3 about CDO’s coming out?
I have. Solid bank - as much as you can call any bank solid.
Besides, I only have enough in there to cover mortgage payments, utilities, etc.
All of my other money is 'other' places so my family won't starve if this goes belly-up.
“I’m Politicket - and who they hell are you?”
Insufficient response. After a post such as that you’d best establish some credibility with the FReepers you intend to “teach”.
Who the Hell are you?
Wouldn’t the number also be affected by whatever is going on in Europe? Four cases: US up, Europe up; US down, EU up; US up, EU down; US down, EU down. Makes it kinda hard to know what is going on by subtracting one variable from a second variable.
Heh, heh. Look at the WTI crude future now (over $100 again). ;-)
The 3-month T-Bill interest rate has gone up a little since I wrote this earlier today for an economic newsletter that I do.
Also, LIBOR itself isn't that great of an indicator. When combined with 3-month t-bills it tells a much better story of a nation's credit risk.
It’s also the last day of the month. The day that a lot of mutual funds try to shore up their biggest holdings so that their returns look better.
Well it’s a good post and you make a good point.
Actually, what it's telling us is that the market is finally starting to charge the correct premium for loans to non-governmental bodies - 3.32%. When banks were able to borrow at essentially the same rate as Treasuries, they took insane risks, endangering shareholders, bondholders and taxpayers in the process. What the banksters want is for us to save them from the consequences of their mistakes by giving them a trillion-dollar handout and, in so doing, inflate the heck out of our currency. Note that until the inflationary period that started during WWII, gold was at $25 per ounce. Today, it's at $900.
By hook or by crook, Jorge Bush is determined to have this bill passed. If you have any savings at all, you need to prepare for the dollar to be worth 1/4 what it's worth today two decades from now. Not quite hyper-inflation, but not a lot different from what happened from the 40's till the 70's.
Why save? Spend. Other taxpayers will provide.
An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.
Laurence J. Peter
Thanks for the informative post.
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