The danger comes because when money stops flowing the subsequent seizure in money and credit markets drains confidence rapidly. All too quickly a downward spiral in liquidity can emerge.
In the summer the Federal Reserve provided positive momentum by cutting rates, but that proved to be a short-lived rally. The TED spread – the difference between Libor and treasury bills – is widening again. This measure of investors’ risk aversion is not quite back to the 225 basis points seen in August, but at 160bp is substantially higher than the level it fell to during October of 100bp and way above the 40bp that applied before the credit crunch.
How can confidence, the lack of which is the real reason for continuing financial markets dislocation, return when news of yet more negative disclosure is bound to be around the corner? Remember that the real pain – waves of foreclosures, rising delinquencies and hundreds of thousands of householders coping with higher mortgage rate resets – is yet to be felt. In addition to the continuing downgrades of sub-prime ABS and ABS CDOs, there are worries about the monolines. ResCap and Freddie Mac’s latest woes are just the icing on the cake.