US corporations are shedding workers at the fastest pace in five years. The official unemployment rate for September is 6.1% If we add in discouraged workers (those who stopped looking for work because they couldn’t find any) plus marginally attached workers and those working part-time because they cannot find full-time employment, then the unemployment rate is standing at 11%. That is up from 8.4% a year ago according to the Bureau of Labor Statistics.

On Tuesday President Bush signed a new law that makes $25 billion worth of low-interest loans available to US auto makers. Ostensibly the loans are to smooth their transition to building more fuel-efficient cars. General Motors, Ford and Chrysler are in bad shape: sales of cars and light trucks fell 27% last month. I don’t think the loans are going to be used to “smooth their transition to building more fuel-efficient cars” -- they need the money just to stay in business.

Economic conditions are bad, so the Federal Reserve Board has changed its stance and is now considering cutting interest rates. The interest rate the Fed would cut is the Federal Funds Rate, which is the rate banks charge each other for overnight loans. I don’t know how much that will help since banks are very loath to lend money to each other right now. What difference does it make if the Fed says they can charge each other less interest for overnight loans if they don’t even want to make loans to each other at current rates?

The London Interbank Rate (LIBOR) is the rate that banks actually charge each other, as opposed to the Federal Funds Rate, which is the rate the Fed wished they would charge each other.

Both overnight and 3-month LIBOR rates have declined steadily over the past twelve months and there wasn’t any material difference between the rate banks charged each other for overnight loans and the rate they charged each other for 3-month loan until about four months ago. Overnight rates are currently about 2%, as per the Fed’s wishes, whereas 3-month rates are climbing fast and are now standing at 4.33%.

This confirms my contention that the current financial crisis is not a liquidity crisis as there is plenty of cash around; instead it is a credit quality crisis. Banks are quite willing lend and able to borrow on an overnight basis, but not on a term basis. They know what bad shape their competitors are in since they’re all in the same shape. That is why the rates they are charging each other are increasing to reflect the increasing risk, and rates will continue to increase in the real economy regardless of what target rates the central bankers set.

Capital is flowing and deals are being done, but not at prevailing “official” rates. Last week I mentioned the Fed’s bailout of AIG, which was priced at LIBOR plus 8.5%. Well, as you can see, that that deal is becoming more expensive by the day. At current LIBOR rates AIG is paying 12.83% for that loan, plus they had to give up 79.9% of their equity.

Berkshire Hathaway did another deal this week: It bought $3 billion dollars worth of GE preferred stock with a yield of 10% and a redemption value of 110% after three years. The internal rate of return on those preferred shares is 12.94% but in addition, Berkshirealso got $3 billion worth of common share warrants to buy stock at a 9.2% discount to the price it was when the deal was announced. Therefore the total value of the investment is more than the 12.94% guaranteed return on just the preferred stock. Keep in mind that GE has a AAA credit rating and it still cost them more than 13% to get some money from Buffett.

Jefferson County in Alabama is in default on its $3.2 billion sewer bonds. It cannot make an $83.5 million interest payment and is trying to renegotiate the terms of the debt with its lenders. Jefferson County got into trouble because the interest rate on its debt soared to as high as 10%. If Jefferson County cannot pay the interest on its debt then perhaps a 10% interest payment isn’t enough to compensate its lenders for the risks they are taking.

Again, this is a credit quality problem, not a liquidity problem. The banks may not have much liquidity or credibility but there is still a lot of money in the economy. Even though asset prices are falling the money supply is still increasing. Therefore it is just a matter of time until fear subsides. Greed may not return for quite a while, but in the meantime deals will get done, capital will flow and businesses will continue to operate. However, the cost of capital is increasing and that means interest rates are going to rise. They have already started rising quite dramatically for the private sector, but most people are fixated on the public sector so they are not seeing this. Eventually, interest rates on public debt will rise as well; it’s just a matter of time.