The Real Bank Bailout: Upward Sloping Yield Curve

The chart above shows the spread between the interest rates for 30-year fixed rate mortgages and the rates for 1-month bank CDs, on a quarterly basis from 2000:Q1 to 2009:Q1. Notice how low interest rate spreads preceded the last two recessions (March 2001 - Nov. 2001 and Dec. 2007 to present) as banks got squeezed and became unprofitable (think “credit crunch” or “frozen credit markets”). Notice also how the interest rate spread widened during the 2001 recession, allowing banks to become more profitable and helping the economy to recover as credit became more available.

Larry Kudlow pointed out recently that “the upward-sloped yield curve is the real bailout for the banking system.” The expected record $3 billion profit for Wells Fargo (WFC) in the first quarter 2009 is a direct result of the upward sloping yield curve and the increasing interest spread in the first quarter to 4.6%. The recovery of the banking sector should also be signalling an overall economic recovery this year, just like the 5% spread signalled the end of the 2001 recession.

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