If 2007 was the year that credit markets focused on mortgage-backed securities, it was the nuts and bolts of bank financing that came to the fore at the start of 2008. “The money markets are still far from healthy”, wrote Edward Hadas on Breakingviews. “Many banks remain in acute need of short-term funds.” Despite central banks pumping money into the system to combat the freeze in interbank markets (where banks make short-term loans to each other), conditions worsened and fear grew. Bear Stearns’ collapse came after other banks refused to offer it more secured loans against collateral, such as treasury bonds. “The sign was unmistakable: credit was drying up,” said Roddy Boyd in Fortune. In the following months, similar tales unfolded at Lehman and the three largest Icelandic banks.
Credit default swaps, or CDS – “which trade the risk that borrowers will not honour bonds”, as The Economist put it – became a buzzword in the summer as CDS sellers realised that this would be a reality with many bank bonds. Forced sales to meet these CDS payments contributed to market plunges during the autumn, and calls grew for CDS to be regulated, or even banned. “The global credit default swaps market should just be liquidated, the contracts allowed to expire and the booby traps defused,” said John Dizard in the FT. Now attention is turning to the risk of a bubble in US Treasuries, where buyers hunting a safe haven had driven some yields down to zero. “A Treasury bill at 0% is overvalued. Who could argue with that in terms of the return relative to the risk?” asked Bill Gross of Pimco.