Global credit rut endures

Hopes that global credit markets might be coming unstuck have been derailed after a spike in key European bank lending rates and data on US commercial paper suggested the lending drought is persisting.

The sense of lingering trouble was reinforced by actions from central banks in both the United States and Europe, which were forced to inject large quantities of cash into the banking system to keep the wheels of global capital turning.

Developments at student lender Sallie Mae were a case in point. The consortium that had agreed to buy the company backed out of the deal this week, forcing its managers to consider accepting a less attractive offer.

The latest housing data also pointed to a vicious cycle of reduced appetite for risk and softer economic activity. The credit crisis started with home loans gone awry. Now, tighter lending conditions were pushing a sharply contracting housing market into an even deeper plunge.

"The decline in new homes sales in August could reflect a fairly sudden change in mortgage finance availability in late spring and early summer," said Michael Bizenov, president of Sterling National Mortgage. "A lot of people who were close to making deals or actually in contract to buy found it more difficult to get financing."

Individuals were not the only ones facing this challenge. Companies were having difficulty raising money too, according to the Federal Reserve's tally of outstanding commercial paper.

The amount of those short-term securities outstanding fell $US13.6 billion ($NZ18.5 billion) over the past week, marking nearly two months of continuous declines that reflect the continuing anxiety. The latest drop left total commercial paper outstanding at $US1855.4 trillion, down a startling 16.6 per cent from peaks set two months ago.

Companies use commercial paper to fund day-to-day operations. Analysts say the longer this retrenchment lasts, the more it could drag down the broader economy.

"The commercial paper market is not deteriorating as fast as it was in August, but as long as outstandings continue to fall, it is not out of the woods yet," said Chris Low, chief economist at FTN Financial. "It's still more accurate to say the patient is less sick than to say the patient is recovering."

In an effort to encourage lending, the Federal Reserve added a total of $US38 billion to the banking system, matching the largest such transaction since the start of the credit crunch. The last time it did anything larger was in the aftermath of the September 11 attacks.

The European Central Bank also stepped in, lending $US5.5 billion on Wednesday at its hefty 5 per cent reserved for emergencies – the largest amount borrowed in this manner in nearly three years.

European banks, which had been large buyers of subprime US mortgages, have been severely hurt by rising defaults in that sector, and by the wider effects of repackaged mortgage-backed securities.

The pain was reflected in a renewed surge in the London Interbank Offer Rate, or LIBOR, for three-month euro deposits. Those were fixed at their highest level in more than six years, reflecting banks' persistently strong demand for cash and reluctance to lend it out.

- Reuters