Credit markets see more gradual improvements

It was clear Tuesday that there is still plenty of fear in the lending business--one indicator, the difference between the rate at which banks lend to other banks and the rate at which they buy U.S. government debt remains near a 25-year high.

But analysts believe that as long as conditions keep improving, the economy should be able to grow.

"I don't think we need to have credit conditions come back to normal before we see signs that the economy is recovering," said Bernard Baumohl, chief global economist at the Economic Outlook Group. He said he believes the financial system won't be fully restored until at least 2010, but that he expects the economy to turn around in the second half of 2009 after the housing market bottoms.

The problem is that the health of the economy and the credit markets is intertwined: The health of the economy relies on credit, and the willingness to lend depends on the economic outlook. As a result, the economy's recovery might be jagged and gradual, as lenders incrementally loosen up as they grow more confident that borrowers are on steadier ground.

And, like an economic recovery, there's no specific piece of data that will signal that things are significantly better in the credit markets. Rather, investors will need to see prolonged, steady improvement on various fronts--bank-to-bank lending, lending to businesses and consumers, and investment in corporate debt such as commercial paper--to get a sense that credit has returned to a healthier state.

Confidence in the lending business grew a bit Tuesday as the U.S. government said it would spend $250 billion of its $700 bailout plan on buying stock in nine major banks, after European governments announced a similar move Monday to recapitalize their own banks. The actions helped bank-to-bank lending rates tick lower, and bring some optimism back to the stock market.

"We are seeing an improvement. It's still frayed, but not as dark as it looked last Friday," said Mark Zandi, chief economist at Moody's Economy.com. "I do think we're making some progress here, and hopefully this is just the beginning."

To be sure, the clogged credit markets are still squeezing businesses, municipalities and individuals.

Domino's Pizza Inc. Chief Executive David Brandon said during the company's quarterly earnings call that although things appear better now than they did last week, borrowing directly from banks has "been very tough, and that's gotten exceedingly worse during the third quarter, and I would say right now it's fundamentally shut down." The seize-up is forcing Domino's to "be creative," Brandon said, and consider offering short-term financial support to its stronger franchisees.