New Spasm Jolts Short Tem Markets

Despite repeated doses of medicine from central banks, short-term lending markets around the world are struggling again. Libor rate is up across Euorpe and US. The unease is alao filtering into other credit marekts, municipals, corporates and mortgages the renewed turmoil marks the latest fallout from the deflation of U.S. housing values and the crisis in the subprime-mortgage market. Banks are at the center of the storm. Though having taken billions of dollars of write-offs on trbouled debt, many banks still do not seem finished with that reckoning process. This has left them constrained for capital, and reluctant to lend out money. The downgrade odd of bond insurerer weigh on the credit market. Short-term money markets are the grease that makes the wheels of financial markets spin smooth. Issuance of short-term IOUs -- asset-backed commercial paper used by banks and other financial companies to raise money -- struggles to find solid footing. Asset-backed paper outstanding rose by $7.6 billion for the week ending Feb. 27, according to the Federal Reserve. But that hopeful sign followed four prior weeks when debt outstanding shrunk. The premium companies must pay to issue high-yield bonds has risen to an average of 7.76 percentage points over comparable Treasury bonds, according to Merrill Lynch, up from a gap of 5.92 percentage points at the end of 2007 and just 4.19 percentage points last June. Meantime, the average yield on a high-quality, tax-free 30-year municipal bond rose to 5.14% last Friday. That was up from 4.25% at the beginning of the year, and well above comparable taxable Treasury bonds -- a historic dislocation. In addition to lowering interest rates, the Fed has tried to make short-term cash readily available to banks through a mechanism called the Term Auction Facility, in which financial institutions can tap the Fed for cash loans and use a broad array of financial assets as collateral. Fed officials have indicated that the facility has been a successful tool, and that it is likely to remain in place. It is also possible that the Fed could expand its use of the facility if money market conditions worsen.