Today's news by the Federal Reserve sparked a buying surge in the markets; the Dow Jones Industrial Index climbed 490 points by the end of the day, up nearly 4.25 percent and, more importantly, breaking the 12,000 mark. The real reason for the Fed's action has to do with the TED Spread, the difference between the interest rates on interbank loans and on short-term U.S. government debt ("T-bills"). In a normal economy, this rate is in the teens, sometimes getting as high as the lower twenties. But in early August, something happened and the TED Spread spiked five points to the mid-twenties; it has continued a steady climb since then, crossing the 50 mark this week. For some perspective, the TED Spread crossed into the mid-twenties in March 2007 and crossed the 50 point in late May; steps were taken to ease the flow of money between banks then, too, but even so the rate only fell to the high-thirties before resuming its climb with even greater vigor.
Why is this important? Those of us reading this don't really lend money to banks, right? Well, yes and no. By having your money in a bank, you are providing the capital not only to pay your own loans, but also the capital to create new loans. This has always sounded like a Ponzi scheme to me, but in theory the banks are paying us for the privilege of using our money in the form of the interest we gain on our cash balances.
Here's the problem. We don't have much interest being generated by our cash balances. As pathetic as the current rate of US Saving Bonds is (0.60% today), they are still a better return than at a big bank (0.50% at Bank of America for Virginia today). With paper savings bonds not being available any more through our lending institutions, they can only be purchased electronically directly through the treasury. This means they are more difficult to counterfeit and can't be lost, as paper bonds could, but it's also a real pain to buy.
At this rate, it's difficult to understand the argument against keeping one's money in a mattress, and that's bad news for banks, but also bad news for the government in general who relies upon the well-oiled functioning of the banking industry. The good news is that you can skip the banks and make more money buy buying bonds.
We'll check in on the overall status of the TED Spread in a few months.