I buy the fact that banks haven’t been as exact as usual lately in estimating their interbank borrowing rates. How could they be? Interbank lending beyond three months has basically stopped. But I don’t buy the argument, implied in Thursday’s Wall Street Journal ($), that since banks’ stated interbank rates have lately decoupled from the prices of credit default swaps on those same banks, that everyone is systematically lowballing their numbers.
Reason: the gold standard of credit rationality the Journal has chosen, the CDS market, hasn’t been the picture of market efficiency itself lately. Take, for instance, CDS prices on the financial services company as insulated from the credit crunch as any: Berkshire Hathaway. From September of last year until mid-February, CDS prices on Berkshire senior debt more than sextupled:
That’s crazy. Berkshire, recall, has something like $36 billion in cash, next to no debt, and a broadly diversified mix of businesses. Nothing changed in its fundamental outlook between September and February that could have caused such apparent deterioration in its credit quality. Instead, the CDS market simply went nuts.
The story’s the same, by the way, for CDS prices on companies that have nothing to do with the credit markets, from Johnson & Johnson, to 3M, to Exxon Mobil.
Might the banks be fudging the interbank rates they submit in London every day? Given the level of nervousness around, I don’t see how they aren’t. But if the Journal wants to quantify the level of fudging going on, it needs to use a yardstick other than CDS prices.