The government's efforts to crank open the credit markets have led to some mild improvements in lending rates and Treasury bill yields. But it will probably take months, perhaps a few years, before lending returns to healthier levels.

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NEW YORK — The government’s efforts to crank open the credit markets have led to some mild improvements in lending rates and Treasury bill yields. But it will probably take months, perhaps a few years, before lending returns to healthier levels.

It was clear Tuesday there is still plenty of fear. One indicator: the difference between the rate at which banks lend to other banks and the rate at which they buy U.S. government debt remains near a 25-year high.

Economy should grow

But analysts believe that as long as conditions keep improving, the economy should be able to grow.

“I don’t think we need to have credit conditions come back to normal before we see signs that the economy is recovering,” said Bernard Baumohl, chief global economist at the Economic Outlook Group.

Baumohl said he believes the financial system won’t be fully restored until at least 2010, but that he expects the economy to turn around in the second half of 2009 after the housing market bottoms.

The problem is the health of the economy and the credit markets is intertwined: The economy’s health relies on credit, and the willingness to lend depends on the economic outlook. As a result, the recovery might be jagged and gradual, as lenders incrementally loosen up as they grow more confident that borrowers are on steadier ground.

And, like an economic recovery, there’s no specific data that will signal things are significantly better in the credit markets.

Rather, investors will need to see prolonged, steady improvement on various fronts — bank-to-bank lending, lending to businesses and consumers and investment in corporate debt such as commercial paper — to get a sense credit has returned to a healthier state.

Confidence in the lending business grew a bit Tuesday as the government said it would spend $250 billion of its $700 bailout plan to buy stock in nine major banks, after European governments announced a similar move Monday to recapitalize their own banks.

The actions helped bank-to-bank lending rates tick lower and bring some optimism back to the stock market.

“We are seeing an improvement. It’s still frayed, but not as dark as it looked last Friday,” said Mark Zandi, chief economist at Moody’s “I do think we’re making some progress here, and hopefully this is just the beginning.”

To be sure, the clogged credit markets are still squeezing businesses, municipalities and individuals.

Domino’s Pizza Chief Executive David Brandon said during the company’s quarterly earnings call that although things appear better than they did last week, borrowing directly from banks has “been very tough and that’s gotten exceedingly worse during the third quarter, and I would say right now it’s fundamentally shut down.”

The seize-up is forcing Domino’s to “be creative,” Brandon said.

Meanwhile, two corporate deals this week have fallen through. French outdoor-advertising firm JCDecaux said Tuesday that negotiations to buy Russian rival News Outdoor Group from News Corp. have ended because financing would be too difficult.

And Monday, Waste Management, the nation’s largest garbage hauler, pulled its $6.73 billion bid to buy smaller rival Republic Services.

In another sign of tight credit, a Tuesday report by the New York Building Congress said New York City will see its construction boom peak this year and construction jobs plunge.

Metropolitan Transportation Authority spokesman Jeremy Soffin said capital projects like the Second Avenue subway line are dependent on access to the credit markets, while Steven Spinola, president of the Real Estate Board of New York, said fewer projects will be financed.

And it’s not going to get any easier for consumers with shaky credit to get loans for homes, cars, and other big-ticket items. GMAC Financial Services, the financing arm of General Motors, said Monday it had tightened its criteria for consumer auto financing. One of the changes was limiting purchases to buyers with a credit score of 700 or above.

Still, it’s a good sign that bank-to-bank lending rates are slowly coming down — a trend that a still-nervous Wall Street hopes will continue.

The London interbank rate, the key lending rate known as Libor, has been inching lower. Libor for three-month dollar loans fell to 4.64 percent from 4.75 percent, after a 0.07 percentage point dip on Monday. Last Wednesday, Libor was 5.38 percent.

Impact on consumers

Libor is important because many consumer loans, including about half of all adjustable-rate mortgages, are tied to it.

It remains well above the three-month Treasury bill yield of 0.34 percent, up only modestly from 0.21 percent late Friday. It’s also much higher than the target Fed funds rate of 1.5 percent.

The fed funds rate is the overnight rate at which banks lend funds held at the Federal Reserve to other banks. Libor is the average bank-to-bank lending rate on the wholesale market.

But another good sign is that the two-year swap spread — the difference between two-year swap rates and two-year Treasury notes — dropped to the lowest point since Sept. 19, noted Miller Tabak analyst Tony Crescenzi.

Swap rates measure the rate that a speculator pays to switch from a floating-rate obligation into a fixed-rate obligation. A drop in the spread means the market is betting that credit spreads will narrow. That means cheaper borrowing.

And spreads on credit-default swaps — the insurance policies bought to protect against bond defaults — also narrowed Tuesday, according to Phoenix Partners Group. That suggests a letup in the fear of corporate failures.

Rates on commercial paper fell, as did rates on high-yield junk bonds. Commercial paper is the short-term debt that companies sell for their financing needs. The Fed says it will start buying commercial paper within days.