Wednesday, April 16, 2008

Crunch Metrics

Probably the best measure of the seriousness of the credit crunch is the ratio of rates for 3-month bank CDs to those for 3-month Treasury bills (see chart below, click to enlarge).

Data: FRB St. Louis

After decades of banks paying just a tad over T-bills for CD funds (ratio slightly over 1.00), their deposit costs exploded upwards reaching 3.20 times more than bills in the week of March 21. This was a somewhat misleading reading, however: with CD rates at 2.62% it was a low 0.81% T-bill rate that caused the ratio to shoot up so much, coming as it did amidst the Bear Stearns panic.

Last week the ratio eased back to 2.10 as bill rates moved up (CDs at 2.75%, Bills at 1.31%), but it is still high by historical standards and a continuing sign of severe risk aversion. Should it persist for much longer it will restrict lending practices even further and wreak havoc to bank profitability.

In a related topic, ISDA today announced that notional amounts outstanding for CDS rose to $62.2 trillion at the end of 2007, up 75% from 2006. The credit crisis is surely prompting many to seek default protection, but I think outright speculation is an even bigger factor. I have often said that CDS can be used as phantom equity equivalents and this comment supports my view: "Trading volume has gone up dramatically,'' said David Vershoor, a default swap trader at BNP Paribas SA in Hong Kong. "People are punting it harder than they punt equities.''

ISDA estimated CDS gross and net market values at at $9.8 and $2.3 trillion respectively which, though lower than notional, have now climbed to be significant on their own. By comparison, global stock market capitalization in February 2008 stood at $56 trillion. And if the Bear Stearns snafu taught us anything it is this: we can't ignore counterparty risk, i.e. we can't ignore gross market values for derivatives. Which ultimately means that notional amounts also matter a great deal and can't be dismissed out of hand as "unimportant".

Data: ISDA


  1. You've talked about this before:

    Degree can't always open door to middle class

    There's no question higher education translates into larger paychecks for most college graduates, but wages for those starting out their careers have declined dramatically during the past decade

  2. eh, good for you!

    I have felt for some time now that education (along with healthcare) has become a social bubble... remember the physics is quite clear: EVERYTHING is prone to bubbles in evolutionary systems, and I mean everything.

    The economic benefits of education clearly also follows 'pareto' like spreads, with certain careers (technical/professional/etc...) representing the overwhelming lion's share of educational income gains. And even for many of these fields, educational ROI is dropping-- making them look like any other bubble.

    Yet society is increasingly demanding more and more educational 'merit badges' from its citizens as the cost/benefit is becoming spurious at best.

    One of the problems is our educational system and college ranking system has become an advertiser of sexual/reproductive fitness in our human primate mating game. And this is obviously the case in EVERY country in the world. If you think the whole Harvard, Yale thing is big in America, try looking at the same phenomena in India, China and Korea, etc...

    Darwinian sexual fitness/advertising has a way of turning 'small' bubbles into 'granddaddy' bubbble (look at the tail feathers of a peacock or any of the other fascinating displays of sexual fitness in the animal kingdom to get my point).

  3. eh:

    I have referred to the costs of a college education (particularly student loan debt) as a barrier to entry to social advancement. While people with college degrees do generally earn more money, the debt levels often -- as a practical matter -- regress people back down (in some cases to a position even lower than they were before). That is particularly true for those who end up in bankruptcy court. Because student loan debt is almost never dischargeable, the risk of starting a new business is amplified.

  4. Okie, buddy... You're soooo close, connect the dots!

    Do you still think the pareto spreads we see in the human genome only come from the actions of a few bad people (i.e. the Genghis Khans of the world)
    and that a well managed government program (preferably run by Democrats) will change the laws of physics?

    Niall of the Nine Hostages.

    Ashkenazi Matriarch

    American Indian Ancestors.

    We are all African.

    You see the 'injustice' in outcomes, you just keep missing its perpetrator.

  5. "Grasp reality with both hand"... what smoking gun do you need?

    I read recently (can't find the link) that a 'drop dead gorgeous' blonde Stanford freshman with near perfect SAT's was recently paid over $500,000 for her eggs.

    Barrier to entry-- that's the whole point!

  6. Awright, Thai, that was some provocative stuff, I'm hittin' the bait!

    So, what are you saying? Simply that disproportionate results are the result of genetics? Or that it's the fundamental trait of life to develop and exploit competitive advantage?

    And that that's perfectly OK, because that's how life survives (combat of the fittest .vs. environmental constraints)?

    If that's not your thesis, pls state it black and white, and let the (civil, mind you) rumble begin!

    Hell: Note on the scorched-earth policy re: civility - I'm unclear about which specific behavior, phrase or attitude resulted in taking down a whole thread. I can't infer it from the evidence provided. If you want rough-and-tumble, you'll have to provide clear guidelines, or you'll end up with Jell-O and head-nodders.


  7. Outerbeltway, neither

    This has nothing to do with whether I think it is 'OK' (is gravity 'OK'?), "it is what it is".

    IF I were going to redesign the universe according to my own wishes, I would do it differently (first thing to go would be conservation of energy-- something most liberals ignore anyway).

    And 'NO', disproportionate results are not the results of genetics.
    Disproportionate results (of which genetics are only one of many 'results') are the results of the laws of physics, most importantly the conservation of energy.

    The problem most people have in understanding this is they do not understand the issue of 'boundaries' and evolutionary systems.

    Focusing ANY more ON the combat aspect of evolution (which is real), over the cooperative aspect (WHICH IS EQUALLY REAL) implies a fundamental misunderstanding of these issues. THERE IS NOTHING BIOLOGIC ABOUT EVOLUTION, REPEAT NOTHING, IT IS SIMPLY A PROCESS AND IS JUST AS APPLICABLE TO NON-BIOLOGICAL SYSTEMS AS BIOLOGICAL ONES.

    As I posted the other day, disproportionate (Pareto) results are a fundamental consequency of "bounded" evolutionary scale free networks. They are as fundamental as gravity.

    Look at your own body, you will see inequality within it VERY quickly even though every cell shares exactly the same DNA/is a clone.

  8. M3ANON said -

    Hello hellasious.

    Thanks for providing your comments to that WSJ editorial I referred to yesterday. I really can't believe an expert in the field would seriously imply that causing inflation is good for the consumer (that is crazy).

    I also want to thank you for another update on the CDS troubles. I first learned about the CDS stuff here on your webpages about 6 or so months ago - when everyone was still talking about SIV's as the only problem. I read an article last week on where the writer claimed that he thought the main reason the Fed helped JP buy Bear was to save the CDS market from imploding (I guess the CDS instruments on Bear are that large - I still don't really get the CDS market in its entirety but I understand enough to recognize that it is still the big ol' elephant in the room).

    Thanks again hellasious.

  9. H

    Am I missing something, or are there a lot of posts on this site today that have nothing to do with the topic of your blog?

    Can we get back to the matter in hand?


  10. M3ANON,

    It wasn't the CDS outstanding on Bear as a corporation that was the trouble. It was that Bear was #9 in the world as a CDS counterparty.


    The rules are simple: don't throw JELL-O.

  11. Why is it the ratio that I should care about, rather than the difference?

    Ratios behave oddly when the denominator is near zero.

  12. re: ratio

    Because a 2% spread (difference) when nominal rates are 10% is less troublesome than a 2% spread when nominal rates are 2%.

  13. H

    With regard to your comment about published gross and net market values in the CDS market - I have been concerned for some time about the backlog in trade confirmations of CDS and other derivatives. My view is that bankers will be markedly less helpful in sorting out any problems nowadays, compared to the past. Then, if a banker denies a trade, why should he worry about valuing it in his trading book?

    Over at, there is a note from "Kamekon" (hat-tip) as follows:

    “ISDA has just published preliminary results of the ISDA 2008 Operations Benchmarking Survey on its website, including the following data on outstanding confirmations:

    In the main asset classes, business days’ (BD) worth of outstanding confirmations is lowest for credit derivatives at 6.6 days, followed by interest rate products at 9.9 business days and 13.3 for equities. In interest rate and credit derivatives, 90 percent of electronic confirmations are normally sent by T+1 (within one day of trade date); equity derivatives reach those levels by T+4.”

    He / she adds – “This suggests that trade processing of credit derivatives has slowed, reversing the trend of previous years: the 2007 Survey lists a 4.9 BD backlog.”

    Link to the detailed 2007 survey is –
    See Charts 2.1 and 2.2 and Table 2.3 in particular.

    Your thoughts?

  14. Confo backlogs are a result of soaring trade volumes. Unlike what you may think, banks hate them. They cause them to stay behind in properly assessing the risk they are carrying on their books.

  15. Re: "severe risk aversion/further restrict lending practices"

    Responsible borrowers are a double-edged sword. They'll pay you back, but you can't fool them into buying more than they've decided they can afford or to use "exotic" products like neg am. The responsible population is saturated so they won't borrow even though they can qualify, the irresponsible population can no longer qualify, and therefore banks are screwed either way.

    Re: civility

    There was a brawl at my favorite web saloon and I missed the whole thing? Intolerable!

    Re: eggs

    500k and insemination will be ARTIFICIAL? (rimshot)

    (Very tacky. Sorry Hell)

  16. H

    I complained earlier today about “off-topic” discussions, so I apologise in advance for doing just that with this posting.

    There is an article in today’s “Guardian” newspaper in London (link is below) which discusses the credit / banking crisis from the British perspective. I am not suggesting that you read the article, as the author is not a recognised financial commentator and some parts of his article will amuse / annoy the regular - much more intelligent - contributors to this blog. What I do suggest is that you read the responses – there is such vitriol in them. If these messages are representative, then this crisis is clearly well beyond the point of “reasoned debate” – and this from supposedly mild and quiescent Englishmen. Revolution beckons!


  17. Oh no fair!

    The kids in the front of the class are telling us kids in the back: "shhhh! Thai, eh, Okie, OuterBeltway and Dink: stop talking... I can't hear the teacher".

    Here I am feeling all guilty and wondering whether I should start my Ritalin earlier, and all the while the front row kids are passing brownnosing notes to the teacher...

    Sheeeze, Maybe Okie is right and us little guys are doomed


  18. Because a 2% spread (difference) when nominal rates are 10% is less troublesome than a 2% spread when nominal rates are 2%.


    Can't I think of a risk premium as what I charge because of the chance I might not get paid back? (I'm a physicist, not a financier, so perhaps I've gone off the rails here.) And if I think there's a 2% chance of not getting paid back, don't I add 200 basis points to the loan, regardless of whether the riskless rate is 2% or 10%?

  19. For Thai (From the front of the class)

    You have every right to point this out !!



  20. Dome-

    Please forgive the derailings. Hell was discussing trillions of dollars and the terrified chimp in me couldn't cope with disaster on that scale. And Thai won't share his Ritalin with us other delinquents.


    The major that the degree is in must make a huge difference. Hopefully the student has considered this before taking on the student loans.


    So OoW was discussing rigid vs. flexible executives. The author proposed the rigids need to keep a few flexibles around for when black swan comes around. Flexibles annoy rigids because they explore instead of focus. Focusing on the game is great way to win....until the black swan changes the game. And then only the flexibles can adapt quickly enough to the new game (then rigids master the new game, rinse, repeat).

    I'm thinking the Ashkenazi and American Indian matriarchs must have been "flexibles" and a black swan event hit during their lifetimes which only they could adapt to quickly enough to (Genghis and Niall could just be prolific due to an anomolous political situation).

  21. dink.
    dont try to overstate the black swan.

    Higher education debtors, pay it off aggressively.

    the spread between the 30 day t-bill and the bank offer to accounts, should be very high. The banks need money, thats what the stimulus check is for.

    Krona overnight collapse, was a function of the velocity of money, the stock market is a velocity of consumption. Consumers are buyers.

    The strognest vote any consumer has is how they spend the money. Thats the whole notion behind moderate disinflation, you dont have the money to do something different.

    Housing deflation and structured debt on a hous of Credit Default Swap Cards.....keep dancing around the derivative mountain, while the snowpack gets real unstable.

    One of the loopholes in the "go long housing" at the momment is the value of the capital loss carryforward. Strong incomes would behoove this cant get much more bullish on a bear market in housing.

  22. Dink, Kudos you are beginning to understand my point (I have never read anything since OOW that better sums my views of the world) but shhh we have to whisper so we don't disturb Dome :-)... (italics means we are whispering and therefore he can't hear us)

    As for the Martiarch, my point is it is always this way! You might reconstruct the path one Matriarch took, recognize how she was 'lucky', etc... (which she was), and think she would never do it again (which she wouldn't), but focusing on her path can distract you from the larger truth that there was always going to be only one winner-- if it wasn't her, it would have been someone else.

    The issue I have been trying to get across regarding morality/boundry's/kin/etc... is that "it isn't fair" is still no excuse for not cooperating. Since no government regulation, no lack of government regulation will ever change this fact, get over it and move on.

    People just do not understand how precious cooperation is in this multiverse we exist in.

  23. Dink
    A black swan event will happen only once, giving her twice as many descendents.
    If it is a "somebody has to be successfull" event, then for every one hundred thousand descendent person there should be ten only ten thousand descendent person.

  24. Dink @ 4:00

    If the average -- meaning everyone, i.e. including liberal arts grads and engineers -- is behaving this way, it cannot be a good thing.

    Dome @ 9:06

    I don't see the point/problem. People don't like bailouts in any shape/form. And they say so plainly.

  25. wkwillis-- can you humm a few more bars, I don't follow

    eh- I agree, that's why I say its a bubble (is complex since people are living longer and can stay at their white collar jobs longer than they could with manual labor jobs-- again assuming there is no golden decades of retirement on the golf course).

    We need to focus on educational productivity (which nobody does), istead of educational funding sources (which everyone does). One truly helps everyone, the other is a smoke and mirrors solution.

    It's the same problem with healthcare by the way.

  26. eh-

    I see your point that its an average that includes all majors. And the science-oriented fields have been competing with India/China during the last decade so its not necessarily a golden ticket.

    Black Swan discussion(not-so-liquid, thai, wkwillis):

    NSL- If I understand the black swan concept correctly, it pretty much can't be overstated. The previous paradign isn't viable any longer due to the scale of the change.
    Thai- I'm not sure I understand the "one winner" statement. Couldn't the event have killed all "agents" (I'm thinking along the lines of a plague that these matriarchs had a resistance to)? BTW, embarrassingly, I don't know how to make an italic font.
    Wkwillis- she wouldn't even need to double her descendents; the other females being eliminated would explain the prevalence of the matriarchs genes.

  27. Dink- this shows how to italicize using basic HTML tags use the letter "i".

    and 'yes', absolutely, everyone can die. My 'one winner' point is there is no way we can change the fact that there will only be a few 'winners' in the evolutionary race for existence (unless we expand the boundaries of our planet and its resources).

    eh-- many non-traditional educational routes now offer MUCH higher return on investment for educational time/dollar than 4 year university programs.

    Just look at nursing today: the shortage means some nurses with only 2 year community college degrees are making >$100,000/year 2 years post graduation (some make more than the physicians they work with). Suply/demand means many are earning this with a relatively small educational time/financial investment when compared with traditional 4 year B.A. or B. S. degrees and far superior educational return on equity. In fact, they are making more than most MBA's from average MBA programs (who needed 6 years and $100,000+ investment after high school)

    Not only should we ignore conventional wisdom for stock investing, we should ignoring it for conventional career/education wisdom.

    Once it is conventional wisdom, it is probably a bubble.

  28. I've been wanting to inquire for a while, and this post seems closest to my inquiry. My federal savings bank is providing 6.01% interest on my checking account. Of course, I cashed in CDs and now have 100% liquidity and higher return than anything else can offer. Why would they do this?

  29. Is it possible that banks put their remaining reserves into commodity futures and thus save themselves? After all, as Fed messes more with the banking system and peak oil comes closer, oil and other commodity prices can only go up. This will allow banks to regrow reserves very fast.

  30. Greenie:

    I hope you were being sarcastic....


  31. geepers...

    6% on a plain vanilla checking account? In dollars? No strings attached? Is it perhaps for a very limited time? Or in conjunction with the purchase of another product?

    If it is none of the above, I would go to the bank manager and ask why his/her bank has to pay twice as much as everyone else for deposits.

  32. The 6.01% program has been in existence for about 7 months; I was so suspect that I didn't join until 3 months ago. The strings are direct deposit, 10 credit card transactions/mo, and electronic statements. Weirder yet, if the account goes over $50K, it all gets just 0.01% interest. I'm baffled.

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