Credit markets remain strained but show signs of thawing

Credit markets showed signs of thawing Thursday but remain far from normal.

In two signs of continued strain, a key bank-to-bank lending rate rose Thursday and the amount of commercial paper in the market fell for the fourth straight week to 15% below the level before the investment bank Lehman Brothers Holdings Inc. filed for bankruptcy.

While lending doesn't appear to be in the same seized-up state as last week, the year-end could prove a difficult time for funding as banks and other institutions try to get their books in order, said Kim Rupert, managing director of global fixed income analysis at Action Economics.

"It looks like the central bank's actions are starting to help marginally improve confidence enough where safe haven isn't the only thing on investors' minds," Rupert said. "But it's only one small step so far. It's going to be a very jagged type of improvement. There's still a lot of factors that are going to keep anxiety at elevated levels."

The London Interbank Offered Rate, or Libor, for three-month dollar loans rose to 4.75% from 4.52% on Wednesday. Just a month ago, three-month Libor was at 2.81%.

That stubbornly high Libor is just one of the reasons that the stock market has been tumbling. When banks are loath to lend, a weak economy has a hard time bouncing back. The Dow Jones industrial average sank nearly 679 points on Thursday to the lowest level in five years.

Libor's sharp jump over the past month is worrisome because consumer loans such as adjustable-rate mortgages are tied to Libor — meaning that those mortgages could become harder to pay. Citigroup analysts recently predicted that continued stress in Libor will result in a 10% jump in defaults for outstanding non-delinquent adjustable-rate mortgages when they reset.

Libor for overnight dollar loans slipped to 5.09% Thursday from 5.38%, but still remains extremely high — especially compared to the target Fed funds rate, a key overnight lending rate that the Federal Reserve slashed Wednesday by a half-point to 1.5%.

Meanwhile, commercial paper outstanding dropped for the fourth straight week. Commercial paper is a type of debt companies sell to get short-term cash, often so that they can maintain their inventories and payrolls. The Fed said commercial paper outstanding fell by $56.4 billion to a seasonally-adjusted $1.55 trillion in the week ended Oct. 8 — that's down from $1.82 billion on Sept. 10, and down 30% from the peak of $2.2 trillion in the summer of 2007.

As companies have a harder time getting financing, businesses and municipalities have been taking action to try to adapt. Connecticut's governor is requesting that banks statewide to contribute at least $1 million each to a lending pool for small businesses. And Apollo Management is offering a $540 million capital infusion to its affiliate Hexion Specialty Chemicals to help Hexion close its takeover of Huntsman Corp; Hexion said it doubted that Deutsche Bank and Credit Suisse Group would provide financing.

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