Credit crunch puts squeeze on businesses

The clearest sign of bank cash hoarding occurred on Sept. 30 when the overnight London Interbank Offered Rate — the interest rate on interbank loans in dollars — soared to 6.88 percent, far above the 2 percent federal funds rate it normally tracks. LIBOR is a benchmark rate for everything from home mortgages to corporate bonds. Says Lena Komileva, Group G7 economist at money broker Tullett Prebon: "These markets were dysfunctional for the past year, but in recent weeks they have become virtually nonexistent." The Sept. 30 spike in LIBOR occurred just one day after the Federal Reserve announced an unprecedented injection of an additional $630 billion into the global financial system, which ordinarily would have driven dollar-borrowing rates to near zero.

The latest vicious circle: Banks are being squeezed for cash because nonfinancial companies, worried they'll be cut off from other sources, are suddenly drawing on their lines of credit. Gannett, Goodyear Tire & Rubber, General Motors, and ServiceMaster are among the companies that withdrew billions of dollars from banks in late September and early October. Even Duke Energy, a huge, financially stable utility, chose to draw down $1 billion from $3.2 billion in credit lines. The looming question is whether banks will be able to meet all of their commitments to provide credit. If companies grab their cash preemptively, "the prevailing mayhem could lead to a funding blitzkrieg … upon bank lenders," wrote research service CreditSights.

Banks face Feb. 1 deadline on compensation The nation's biggest banks face a February deadline for submitting employee compensation plans to the Federal Reserve, according to people with knowledge of the process. Obama: Job losses expected to continue Consumer spending tumbles, incomes flat Economy grows at best pace in 2 years New jobless claims drop slightly

Skeptics point to the increase in lending to Duke Energy and others as evidence that there is no credit crisis. Alan Reynolds of the libertarian Cato Institute calls talk of a credit freeze "hysterical chatter," noting that all types of lending have risen over the past year. But much of the increased lending is involuntary. Banks are being forced to take assets back onto their balance sheets and keep loans they once would have shed. "That's actually the crux of the problem," says Lou Crandall, chief economist of Wrightson ICAP, a Jersey City, N.J., research firm.

Building a firewall
Under these conditions, the government bailout plan seems like weak medicine. The Senate bill takes a further step toward protecting the banking system by raising the limit on FDIC-insured deposits to $250,000 from $100,000. But that may not go far enough. Some economists say the U.S. should build a firewall against panic by at least temporarily emulating Ireland, which on Sept. 30 said it would insure all debts of its six biggest financial institutions. James Galbraith, an economist at the University of Texas Lyndon B. Johnson School of Public Affairs, is among those who favor that approach.

That's not the only possible solution to the crisis. But it's clear something has to be done — soon — to keep a dysfunctional banking system from wrecking the global economy.

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