Credit spreads are indicative of the willingness of banks to lend money. A review of certain credit spreads offers insight into how the lending market is performing and whether government initiatives, like the Troubled Asset Relief Program [Note: Treasury Secretary Timothy Geithner is renaming TARP as the “Financial Stability Plan” on Feb. 10, 2009], are working.

LIBOR-OIS Spread

The LIBOR-OIS spread is used by economists and financial analysts as a measure of the availability of cash among banks. The higher the spread, the fewer available dollars. The London Inter-Bank Offered Rate (LIBOR) is the interest rate that banks charge each other for three-month loans in U.S. dollars. The rate is set by a panel of banks in a survey by the British Bankers’ Association each day around noon in London. LIBOR is also used as a benchmark for approximately $360 trillion of financial products across the globe. The overnight indexed swap (OIS) rate is an interest rate swap transaction in which the overnight rate is exchanged for a certain fixed rate.

3-Month LIBOR/ OIS/ Spread

Feb. 6, 2009: 1.23/ 0.26/ 0.97
1 Month Prior: 1.26/ 0.19/ 1.07
3 Months Prior: 2.29/ 0.58/ 1.71
6 Months Prior: 2.8/ 2.05/ 0.75
1 Year Prior: 3.09/ 2.62/ 0.47

The LIBOR-OIS began rising more than one year ago, when the credit crisis began with defaults in subprime residential mortgage loans. It reached a peak last Fall when the credit crisis resulted in a complete freezing of credit markets. Since then, the spread has eased, but remains more than twice the elevated level of one year ago. In other words, lending is slowly returning to the market, but is still far from normal. By comparison, the LIBOR-OIS spread averaged 9 basis points (.09 percent) in the 12 months before the credit crisis began in August 2007.

TED Spread

Another slightly positive sign of credit market thawing is a measure of the cost of credit, the TED spread, which is the difference between what the government and companies pay for three-month loans. It declined two basis points to 95 basis points, compared with a record high of 464 basis points (4.64 percent) on Oct. 10, 2008.

[SOURCE: Originally published at Raw Finance]