We’ve seen the movie – will the sequel be released? 

 The credit crunch has seemed to be consolidating and the fall-out has been gathered and swept up, but is this the end or are we to be subjected to the horror’s sequel.

 Current volatlity in the currency markets certainly indicates that the dust hasn't entirely settled.The credit market is still decidedly jittery.  According to a report by the Telegraph, the price of credit default swaps, effectively insurance on those institutions failing to pay out on their own bonds has risen dramatically over the past few days, which indicates that default at some level is expected.

 As Bear Stearns tumbled downhill to its sale to JPMorgan Chase in March,  the cost of protecting its debt, through a credit default swap, began to rise rapidly as investors feared that the Bear would not be good for the money promised on its bonds.

 Is this current rise indicative of other bank vulnerability?

 Inter-bank lending rates across Europe have also jumped sharply while we eagerly await the results today of the BBA investigation into the BBA LIBOR rates. It was feared that some of the 16 banks responsible for setting the rate on a daily basis were understating the cost of their international borrowings to avoid the spotlight. The results of this investigation will be published today.

 As the housing market falls, squeezing personal loan capacity and commodity prices rise, increasing the cost of living, the man in the street becomes hard pressed to honour his current debt levels.  Add job losses to the equation and the pack of cards tumble and the queen of hearts squeals “off with their heads!” We could well see a wave of personal loan defaults other than those already seen in the US sub-prime housing market, in personal debt such as credit cards, personal loans, as well as mortgage debt in the ‘prime’ market’.

 There is also additional fear that the defaulters will spread to the corporate market, which until now has been exemplary under the circumstances.  Rating agencies have been very generous with their ratings in times of plenty which encouraged banks to lend freely to companies they might previously have avoided and would avoid today if given the option. They saw good sub-prime borrowers fall into default – and are hoping not to see a repeat performance on the “prime” stage.

 The sequel could be the Horror Movie of all time as the Fed exits as the hero and savior as its ammunition is spent.  It has poured hundreds of billions of dollars of liquidity into the system.  It has cut the interest rates, it bailed out Bear Stearns.  Short of printing dollars and creating an inflation nightmare, it has a limit to the rescues it can perform.

 As Tony Bonsignore remarked yesterday in his Morning Line: ”All of which is quietly terrifying the banks into an existential crisis; at some point soon they might be left on their own to deal with the consequences of their actions. Just imagine that. “