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Lending rates fall to pre-Lehman levels

Interbank borrowing costs fall to five-month low as government initiatives to ease credit crisis take hold. Bonds rise as Americans cast their votes.

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By David Goldman, CNNMoney.com staff writer

Who has the better plan for the economy?
  • John McCain
  • Barack Obama
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NEW YORK (CNNMoney.com) -- Lending rates fell Tuesday to levels not seen since before Wall Street's credit crisis erupted in mid-September.

The 3-month Libor rate dropped to 2.71% from 2.86% on Monday, marking its lowest point since June 9. This is also the first time the rate has sunk to pre-credit crisis levels before Lehman Brothers announced its bankruptcy on Sept. 15.

The overnight Libor rate fell for the seventh-straight day, dropping to 0.38% from 0.39%, according to Dow Jones. It was overnight Libor's lowest level since the British Bankers' Association began calculating the rate in 1997.

Libor rates have been trending downward since mid-October, when the Fed took the unprecedented move to flood 13 central banks around the globe with unlimited amounts of dollars. Libor, the London Interbank Offered Rate, is a daily average of what 16 different banks charge other banks to lend dollars in the U.K.

Less than a month ago, 3-month Libor was at 4.82%, and the overnight rate was at an all-time high of 6.88%. Lower rates are a major boost for the strangled credit market because more than $350 trillion in assets are tied to Libor.

A number of U.S. government programs aimed at easing funding concerns for banks and encouraging lending between financial institutions have also helped lower Libor rates. Such initiatives include lowering interest rates, injecting capital into banks and providing insurance on all non-interest bearing accounts.

Still, credit remains tight. The Federal Reserve's senior loan officer survey released Monday showed banks and individuals reporting in October that loans were available but expensive as demand declined.

"Lower rates are a sign that conditions are starting to loosen," said Kim Rupert, fixed income analyst at Action Economics. "But lenders are still very reluctant to lend, especially longer term."

A conclusion to the presidential election may help ease credit, but a return to normalcy may take a while longer.

"Tuesday's election will give the markets an even bigger boost of confidence, but not enough confidence that will really restore the market wholly," said Rupert. "The market faces a lot of challenges ahead that will prevent the election results from bringing credit back to normal."

Credit slow to improve

Credit remains tight but two key indicators of risk sentiment showed that confidence in the market is improving.

The Libor-OIS spread fell to 2.11 percentage points from 2.23 points on Monday. The spread measures the difference between actual borrowing costs and the expected official borrowing rate from the Fed. It is used as a gauge to determine how much cash is available for lending between banks. The bigger the spread indicates less cash is available for lending.

Former Fed chairman Alan Greenspan has said that the Libor-OIS spread will serve as a good gauge for when credit has returned to normal. Though the indicator has fallen from a high of 3.66 points set last month, it is still far above the 0.11 percentage points seen prior to Sept. 15.

Another indicator, the "TED spread," fell to 2.22 percentage points from 2.42 points on Monday. The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk. The higher the spread, the less willing investors are to take risks.

The TED spread has fallen from an all-time high of 4.63 points set in mid-October. It was at 1.04 percentage points just days before Wall Street's crisis.

"Conditions are improving, but they're still not anywhere near normal," said Rupert. "There are still a lot of problems in the system."

Bonds rally as America votes

Treasury prices rose Tuesday, even as stocks ended the day higher. With new economic policies on the line in a close presidential race, investors awaited the election's outcome, as voters cast their votes.

"Bonds are waiting for the results, but with big gains in stocks and a huge amount of supply coming down the road, Treasury prices are surprisingly not giving up a lot of ground," said Rupert. "It's symptomatic of the underlying pressure on the market."

Later in the afternoon, however, longer maturity government bond prices rallied. Signs of confidence in the credit markets and corporate bond market gave investors enough feeling of stability to purchase longer term Treasurys, according to William Larkin, portfolio manager of Cabot Money Management.

"If I think there is going to be an uncertain economy, then I am not going to own the 10-year or 30-year," said Larkin. "I am going to stay in the 6-month or the 3-month, which is the bunker trade."

Positive sentiment about the election was also giving investors reasons to invest longer term. "Because the leaders that are dictating a lot of the recovery conditions are about to change," said Larkin, "now people can plan."

The government said Monday afternoon that it anticipates borrowing $550 billion in the fourth quarter and $368 billion in the first quarter of 2009 as it looks to fund the massive financial rescue costs.

The benchmark 10-year note rose 1-16/32 to 102-6/32, and its yield fell to 3.73% from 3.91% late Monday. Bond prices and yields move in opposite directions.

The 30-year bond jumped 2-5/32 to 105-5/32, and its yield fell to 4.20% from at 4.34% on Monday.

The 2-year note was up 4/32 to 100-8/32, and its yield fell to 1.39% from 1.44% late Monday.

The yield on the 3-month bill rose to 0.49%, up from 0.47% on Monday. The yield on the 3-month Treasury bill is closely watched as an immediate reading on investor confidence. Investors and money-market funds shuffle money into and out of the 3-month bill frequently, as they assess risk in the rest of the marketplace. A lower yield indicates that investors are less optimistic.

"Bill rates are still very low, because of the ongoing nervousness about credit conditions, the economy and how deep the recession will be," Rupert said.

Treasurys had been higher Monday as stock prices fell on fears that the economy will continue to weaken.

With additional reporting by Catherine Clifford, CNNMoney.com staff writer. To top of page

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