The Falling Knife of Credit Spreads
Let's talk about credit spreads for a moment. The "spread" is the difference you pay, typically over LIBOR (or the London InterBank Offered Rate). LIBOR is the most important interest rate in the world, as massive amounts of debt are set according to it. Let's say you are an AAA-rated borrower. Last summer you might have been paying as little as 3.84 basis points over LIBOR. If LIBOR was at 5%, you would be paying 5.0384%. There was very little premium for what was considered risk-free money.
Today you are paying as much as 1.89% more. Granted, 3-month LIBOR is now at 3.10, down 2.16% over the last six months, due to aggressive Fed, Bank of England, and ECB (European Central Bank) action. Thus your net cost of funding is the same, but only if you are AAA. There are actually very few AAA borrowers in the world. Let's look at how your costs may have risen if you are still barely investment-grade at BBB.
Now you have a problem. Your costs may have risen from a mere 1.45% over LIBOR to as much as 13%! The spread on some junk bonds is running as much as 18%! (All this data can be had at www.markit.com) This is a credit market that is in serious trouble. No one wants to lend unless they can be sure of getting repaid, so the price of risk is rising rapidly.
