Thursday, January 22, 2009

What’s up with TED?

Since the credit market hit the fan in September I’ve become an armchair economist. That’s because following our economy is more exciting than following sports. It’s unpredictable, erratic, and paralyzing even to the most brilliant policy minds in our nation.

Along the way, I’ve learned about a bunch of data points and indices, but one that’s a favorite of mine is called the TED spread. It’s not a household name, but it’s nonetheless a window into the soul of capitalism. The TED spread measures the difference between the three-month London Interbank Offered Rate (LIBOR) and the return on interest rates from the three-month U.S. Treasury bill. During normal times, the TED spread is less than 1, meaning banks are lending to each other at a similar rate to what the government pays out on interest. But these aren’t normal times.

In September when Lehman Bros. collapsed and AIG’s near-failure required government intervention, the TED spread went haywire. It shot up to 4. The chain reaction was quick. Banks didn’t know who to trust, so they stopped lending to each other. Capital stopped flowing, which meant the pool of money available to businesses dried up. Without capital, businesses had to make tough decisions by trimming jobs, paring away unprofitable initiatives or just closing shop.

Here’s the good news. The TED spread is back at the pre-Lehman levels of around 1. While it doesn’t mean we’re out of the woods, it does show things are moving again, albeit slowly. So keep your eye on TED. Where it goes, tangible action is sure to follow.

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