Looking back on the financial crisis of 2007-2009, it’s clear that the month of October 2008 was “Financial Ground Zero” according to most indicators, including three closely watched measures of financial and credit market risk. As we close out 2009, it’s also now clear that all three market indicators have returned to their pre-crisis levels, suggesting that U.S. financial markets have achieved a full recovery from one of the worst financial crises in recent history.
1) The TED Spread, a gauge of credit market risk (measured by the difference between the three-month LIBOR rate and the three-month risk-free Treasury bill rate) jumped by 65.5 basis points (bps) on September 15, 2008 as Lehman Brothers filed for bankruptcy and fears about credit risk spread. Two days later, on September 17, the TED Spread rose another 82.6 bps to close above 300, setting a record that still stands for the largest one-day increase in credit risk. At the height of the financial crisis a month later, the TED Spread closed on October 13, 2008 above 456 bps, the highest credit spread ever recorded. As the credit markets have gradually healed over the last year, the TED Spread has fallen to the current level of only about 20 bps, which is below the level that existed before the financial crisis in 2008 (see chart above) and less than half of the 49 basis point average spread since 1990.
2) The Chicago Board Options Exchange Volatility Index (VIX), a measure of investor anxiety about the U.S. stock market (sometime referred to as the “fear index”), soared to an all-time high of 80.06 on October 27, 2008 as fear and anxiety reached record levels (see chart immediately above). Just two months earlier, in late August of 2008, the VIX was actually trading below its historical average of 20.28, before skyrocketing more than 60 points to close above 80 in late October for the first time in the history of the VIX. Investor anxiety gradually subsided throughout 2009, and the VIX just fell below the benchmark level of 20 on December 22 for the first time since August 28, 2008, and closed below 20 three days in a row for the first time since late May 2008.
3. The Bloomberg U.S. Financial Conditions Index provides a daily measure of the relative health of the U.S. financial markets, bank lending conditions, and the overall availability of credit. A little more than a year ago, in the wake of Lehman’s collapse, the Financial Conditions Index plunged from -2.51 in mid-September 2008 to -11.3 by October, registering an unprecedented fivefold increase in financial market risk within one month (see chart immediately above). Market conditions have now improved to the extent that the Bloomberg U.S. Financial Conditions closed above zero last week for the first time since August 8, 2007, more than 28 months ago, and for the first time since July 2007 it had three consecutive days in positive territory.
Bottom Line: All three of these important and closely watched financial market indicators have returned to their pre-crisis levels, and can be added to a growing list of economic and financial indicators suggesting that: a) the financial markets have fully recovered from the financial crisis, b) the Great Recession is over, and c) the economic recovery is real.