Thursday, October 9, 2008

TED Spread

Many people have asked if I can explain the seriousness of the financial crisis to them. They understand that the stock market is dropping and foreclosures, but do not understand the financial crisis itself.

I don't understand all of the crisis. Nobody does. However, I will try to illustrate its seriousness.

I am not sure how many of you are familiar with the TED spread, so I will provide a basic explanation. 3-month US Treasury bills are consider riskless. That is to say that the probability of not getting your money back is zero or so close to zero that it might as well be zero. The London Interbank Offered Rate, or LIBOR, is the rate at which banks lend to each other and especially safe companies. Think General Electric. The TED Spread is the difference between LIBOR and 3-mo US Treasury bills. Since T-bills are considered riskless and LIBOR represents the most credit worthy borrowers in the world the TED spread is a proxy for how the market views risk.

As you can see, there was a big jump last August when this all began, and out of control right now. You can imagine this as the heart beat monitor for the economy. We want it pulsing down near the bottom in a calm manner. Huge spikes are bad.


If you are interested, you can monitor the TED spread here.

Carthago delenda est

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