Days away from the anniversary of Lehman's collapse, it's interesting to assess the degree to which financial markets and institutions have changed since. Today: interest rates.
Central banks aggressively cut rates after the first tremors in the financial system in 2008. Money markets at first reacted to Lehman by seizing up. The Libor-OIS spread, which measures the premium banks pay for borrowing from each other and indicates banks' perception of the credit quality of other banks, surged to 364bps from a mean of 10bps. Now the spread is back to a normal level at 13bps.
Libor also surged after Lehman collapsed. 3-month Libor peaked at almost 5% a month after the bankruptcy. Now that Central Banks have committed to maintain their low rates until recovery is assured, Libor is flirting with its record low at .30%. The low Libor rate also reflects the vast amount of government guarantees in the market. Another measure that has returned to normality is the 2yr US Swap Spread. The swap spread measures the spread between treasury yields and swap rates (Libor) for a given maturity. The 2yr swap spread is now at its lowest level in 5 years. Credit hasn't been this cheap in a long time. The new trust with which banks lend to each other, reflected in the Libor-OIS and swaps spreads, isn't healthy and organic but fake, propped up by implicit government guarantees.
The one measure that is distinctly different from pre-Lehman is the 30 year swap spread. A little more than a month after Lehman failed, the 30-year swap spread dipped to negative 25bps. Since then, it hasn't moved much as swaps and treasuries increased at a similar pace. The market is saying it views 30-year treasuries as riskier than 30-year swaps. In other words, the US government has higher credit risk than AA rated companies. This is curious because it is clearly a mispricing--the US government has no default risk. It could reflect negative sentiment about the US' ability to repay its long-term debt, but I doubt it. The FT wrote the negative spread is a result of firms wanting to hedge against deflation without paying the principal and a revival of demand for interest rate hedges. That seems plausible. But it is still a strange inefficiency. I would expect someone to be able to arbitrage the difference.
If one looks at the numbers, it seems as if the US is emerging from a deep recession and that interest rates should rise soon. But yield curves do not predict this. The amount of government intervention necessary to quantitatively ease yields taints these optimistic numbers. Libor and swap spreads indicate that the panic is gone, but yield curves indicate a large amount of government assistance is still required. There is yet something rotten in the state of Denmark.
