Monday, July 21, 2008

The Credit Crisis is Far From Over

From today's WSJ:

Banks also are pulling back on the amount of rainy-day money they have been giving out to corporate clients in the form of loans called revolving-credit facilities. Retailers such as Sears Holdings Corp. and Talbots Inc. have struggled to renew revolving-credit facilities with their bankers in recent months. Other companies, including Wal-Mart Stores Inc., AT&T Inc. and American International Group Inc., have had to agree to tougher terms on such credit.

Overall, the value of credit held by banks in the second quarter shrank 1.5% from the first quarter, according to Federal Reserve data. That was the largest three-month contraction since 1948.

These tight credit conditions are particularly worrisome because the Federal Reserve has responded aggressively since the credit crunch emerged last July. The central bank has cut interest rates seven times by a total of 3.25 percentage points.

Retailers having a harder time getting credit indicates there is concern about the strength and/or sustainability of retail spending. Also note that Wal-Maryt -- the largest retailer in the world -- had to agree to tighter lending controls. This is a company with 378 billion in revenue last year. They have to agree to stricter lending standards.

This is why last week's euphoria regarding the financial sector was so completely overblown. Everyone was thrilled because several banks reported losses that weren't as large as feared. That was the good news -- banks didn't lose as much money as projected. Yet they still lost lots of money and wrote down lots of debt. And all of those writedowns are starting to crimp lending.

Much of the decline in outstanding credit has been due to banks sharply reducing the amount of bonds and other debt securities held on their books, but the slowdown is apparent across all forms of lending. The heavy losses banks have taken on mortgage-related securities are forcing them raise cash levels, leading to tighter lending. Because they can't know what other problems might be lurking on their balance sheets, they are being especially cautious.

None of this should be surprising to anyone. We have seen over $400 billion dollars in writedowns. We have seen 266 mortgage lenders shut their doors. All of this is bound to have an impact -- which it has in the discount spread:

Also note that LIBOR is still higher than the discount rate.

Ladies and gentlemen -- anyone that is recommending you move into financial shares is an idiot. There are still major problems out there. Credit standards are tightening and loans are getting harder to come by even though the Fed has (again) lowered interest rates to 0% after adjusting for inflation. None of this is good news.