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  • Financial System Risk: More on Today vs. the Past

Economy

09 Oct 2008

Financial System Risk: More on Today vs. the Past

  • By Bill Conerly
  • In Economy
  • 2 comments

After posting a long-term TED spread chart yesterday, I wanted to add a look at junk bonds.

(I also realized I didn't explain the logic behind the TED spread.  If it's obvious to you, skip this paragraph.  When banks have extra cash lying around, two of the choices on how to invest it are to 1) deposit it with another bank, or 2) buy Treasury bills.  Treasury bills are the safe choice, but pay a low interest rate.  Depositing with another bank isn't quite as safe as buying T-bills, but it usually comes very, very close to being as safe.  Just how close the risk of a bank is to the risk of the U.S. Treasury can be seen in the TED spread, which is the difference between LIBOR (London Interbank Offered Rate) and the yield on T-bills.  It's the extra interest that a bank has to pay to get another bank to make a deposit rather than buying T-bills.  And we're not talking about deposits at small country banks, but the major London banks.)

To the TED spread I have added the difference between yields on junk bonds and U.S. treasury bonds.
RiskSpreads

I don't think there's anything to be learned from comparing the levels of the two spreads; I use this chart to help compare current events with past events.  (Unfortunately, I can't find a good junk bond data series that goes back very far, because prior to Michael Milken, there was little interest in junk.)  By the way, the most recent daily observation on the junk spread is much higher than the September monthly average, but it's a bit misleading to throw in a single day when the rest of the data are monthly averages.

My economic forecasting implication of the financial crisis: this is not outside the range of what we've lived through in the past.

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    Comments

  1. Phil
    October 10, 2008

    I welcome the unapocalyptic tone of these posts, but…
    I thought that the problem with the financial system today, as opposed to (say) 1975, was that the economy is more tightly coupled, and thus what may have been a WSJ byline back then, actually matters to large non-financial institutions now.

  2. Money Services
    December 16, 2008

    Thanks for the information on topics.I was excited for this article.
    Thank you again.

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