[August 24, 2008]

St. Louis Post-Dispatch David Nicklaus column: What's the third hit on our economic head?

(St. Louis Post-Dispatch (KRT) Via Acquire Media NewsEdge) Aug. 24--In the last few decades, we've become used to thinking of financial panics as temporary aberrations. The stock market crash of 1987, the Asian crisis of 1997 and even the turmoil that came after the 9/11 attacks were measured in days or weeks.

Not so for the global credit crunch that began in August 2007. A year later, financial institutions are still watching each other warily, unsure who's a good risk and who's not. As a result, the price of risk remains at a historically high level.

Take mortgage rates. Thirty-year mortgages still go for about 6.5 percent, as high as they've been in six years. Relative to U.S. Treasury bonds, whose yields have fallen, mortgage rates are as costly as they've been in 20 years. And those are for loans to prime borrowers, not the subprime stuff that got us into this mess.

Businesses are paying more to borrow, too. From 2004 until early last year, corporations with an investment-grade debt rating could borrow for about 1 percentage point more than the Treasury would pay. Now, that spread has widened to more than 3 percentage points.

Measuring the depth of the credit crunch involves some staggeringly large numbers. The Federal Reserve and the European Central Bank have injected hundreds of billions of dollars into credit markets just to prevent a total collapse. The financial system has written off half a trillion dollars in subprime mortgages and other bad debts.

The casualties have included prominent firms like Bear Â-Stearns and IndyMac Bancorp in the United States and Northern Rock in Britain.

At some point, financial markets will decide that most of the losses are behind us. Risk premiums will drop to more normal levels, and it will become cheaper to finance the purchase of a house or the expansion of a factory.

That point isn't yet in sight. "Unfortunately, no," said Scott Colbert, head of fixed-income investments at Commerce Trust Co. in Clayton. The most optimistic thing he can say is this: "We're a year into this (credit crunch) and it doesn't appear to be getting any worse."

It's not getting any better, either. Colbert predicts that the crunch will last about another year, and he said we'll probably experience at least one more "cathartic event" before it's over. That might be a government bailout of Fannie Mae and Freddie Mac, or it might be the failure or near-failure of another large financial institution.

Twice this year -- after the Bear Stearns failure in March and after the government said in July that it would stand behind Fannie and Freddie -- the market has seemed to breathe a sigh of relief.

Each time, credit conditions eased and some experts predicted that the crisis was nearly over. But each time, risk spreads quickly returned to their earlier peaks. "Now, we're building toward a third peak," Colbert said. "Historically, you've usually got to be hit on the head three times before you get through something like this."

Bill Greiner, chief investment officer at UMB Bank in Kansas City, agrees that there's plenty of "event risk" in the system. The share prices of Fannie and Freddie, and of such beleaguered companies as Lehman Brothers, National City and Washington Mutual, show it.

Greiner thinks markets are beginning to focus more on such company-specific risks, and less on the prospect of a systemic panic like those of 1908 or 1929.

That's progress, of a sort. Don't be surprised, though, if another year goes by and we're still talking about the credit crunch in the present tense.

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