by Guest Author Michael Haltman of The Political Commentator, where a version of this post appeared with the title: Why does global liquidity matter to me (and what is a TED Spread)?
Do we, the average world citizen, want global banks and other financial institutions to be comfortable lending money to each other at low rates with the full expectation that it will be paid back?
We do because this "liquidity" is what greases the engine of economy's and markets.
Follow up:When the system is not working well, the banks are not as sure that they will get paid back, and will be more reluctant to lend to each other. In this case they would charge each other higher rates to compensate themselves for what they perceive as higher risk. These rates can get so high that it is no longer feasible to borrow, and at that point global liquidity, markets and economy's grind to a stop.
This is the situation that the world faced during the global financial crisis in 2008, and the question is whether we may face it again now.
The TED Spread!
As a barometer of the "flight to quality" of funds around the world, the TED Spread is a gauge of investor comfort, panic and the willingness of banks to lend money to each other.
The Ted Spread is the difference as quoted in U.S. dollars, between the 3-month treasury bill and the 3-month LIBOR rate.
The value of the TED Spread during "normal" times is typically .10 to .50 basis points (currently .24). In other words if the 3-month treasury was 1.1% then the 3-month LIBOR rate would be anywhere from 1.2% to 1.6% (current 3-month rates are much lower).
During the height of the 2008 financial crisis, the TED Spread grew to as large as 465 basis points! This meant that using the same hypothetical 1.1% 3-month treasury bill rate, the 3-month LIBOR would have been 5.75%!
As a result, in 2008 there was a global liquidity freeze that the Fed at the time helped to end.
Does the world face a new liquidity crisis in 2011?
Flash forward to today where there is currently record interbank lending using the bonds of Europe's governments as collateral. This is occurring despite the various concerns including the still very real potential for a Greek debt default.
By the same token, interbank lending without collateral is currently non-existent, a clear indication of the lack of confidence that one bank has in another banks ability to pay them back over the next week, without getting some protection first.
Is this the beginning of a new phase of the global financial crisis? For starters keep an eye on the TED Spread! An interactive daily chart can be found at Bloomberg. The four graphs below show the TED Spread charts for 5 years, 3 years, 1 year and 6 months, in that order.
Editor's note: While your watching for signs of stress, the TED Spread can be traded by combining trades of futures contracts for Treasuries and Eurodollars, as described in a paper from the CME Group.
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