Credit markets head into uncertain 2009

NEW YORK -- The credit markets, long a shadowy and little understood part of the financial system for many investors, turned into headline makers during 2008, simply because they stopped working.

And, at the start of the new year, they're still far from a level that anyone would call healthy — banks aren't lending freely despite the government's $700 billion rescue package. Yields on short-term Treasurys are still close to zero, indicating how fearful investors still are.

"I'm still waiting for the credit markets to open up," said Scott Fullman, director of derivatives investment strategy for WJB Capital Group in New York. "There's been some improvement, but not that kind everyone has been waiting for. The credit situation will still be the big story in 2009."

The paralysis that swept over the credit markets after the mortgage crisis felled Lehman Brothers Holdings in September was a major contributor to a two-month plunge on Wall Street and has also helped exacerbate the recession that started in December 2007. When Lehman went into bankruptcy, other financial institutions stopped lending to each other, and the normal flow of business in the U.S. and ultimately in other countries was disrupted.

Lending rates in what's known as the interbank market soared during the fall as banks, fearing there could be another downfall like Lehman's, demanded more money from prospective borrowers — those that they would agree to lend to. Companies couldn't secure the short-term loans known as commercial paper, and consumers had a hard time borrowing for homes, cars and college tuition. Municipal governments were forced to pay sharply higher interest in order to sell or roll over their bonds.

The stagnancy in the credit markets forced the Federal Reserve and other central banks to make a series of moves including interest rate cuts — the Fed's benchmark federal funds rate is now near zero percent — and cash infusions into the global banking system.

The Fed is also taking steps including buying some kinds of commercial paper. And the Treasury Department's rescue plan, which started with investments in banks, has also included purchases of some of the failed mortgage assets that started the credit spiral.