LIBOR defined, and why you care
October 11, 2008 – 10:40 amA reader asks “what is LIBOR?” This is important people. Here’s the nutshell:
Libor (pronouned “lie-bore”) = London Interbank Offered Rate. (There are four of them for different maturities, but for simplicity let’s just think of LIBOR as one interest rate) It’s the interest rate banks charge each other for short-term loans. It’s also the reference interest rate for trillions of dollars of adjustable rate debt. Ever wonder how banks adjust the interest rate on an adjustable rate mortgage? Many use LIBOR. So the fact that it’s spiking is can be bad for someone with an ARM loan tied directly to LIBOR. But more important, its ridiculously high level relative to Treasuries indicates that banks won’t lend to one another. When banks can’t borrow, they can’t function.
Credit markets are the world’s financial circulatory system and the blood has simply ceased flowing. The only lending that’s happening right now is courtesy of governments. Think of the world’s credit markets as being on life support. They’d already be dead if it weren’t for trillions of dollars in loans provided by governments and central banks.
Since this is a credit market problem, the stock market is not the indicator you should be watcing. Google “TED Spread Bloomberg” That will bring up a chart that shows the spread of LIBOR vs. Treasuries. It hasn’t been this high since 1973. The worldwide financial system is suffering a terrible fever and that chart is the thermometer. If the fever doesn’t break, we’re financially f***ed.
(Some think Central Bank lending is making LIBOR worse….)
Posted in Economy, Fed, Interest Rates, banking, credit crunch |
4 Responses to “LIBOR defined, and why you care”
“If the fever doesn’t break, we’re f***ed.”
Nice way to put it. If it breaks it’s a nasty recession lasting 2-3 years, If not and the government / wall St “experts” meddle it’s global depression so we’re screwed one way and totally fu*ked the other way and the worst thing is there is no pleasure in it for those hit the hardest
By gin on Oct 11, 2008
“the fact that it’s spiking is BAD for anyone with an ARM loan”
not true. many ARM loans are based on the MTA index, which is an average of US treasury yields.
the margin for MTA based ARM loans for borrowers with good credit is anywhere between 2.25 and 2.75. with the MTA currently at 2.479, this results in an interest rate of 4.729% - 5.229%. not bad at all.
By gentleman jack on Oct 11, 2008
To gin–
We won’t have a global depression of the sort that could and might happen here. I think most countries will think of their own self interest first (or an least, eventually) before they go down with the American ship.
They’ll cut their currency links with the dollar.
By Lisa on Oct 11, 2008
Don’t you guys get it?
The money multiplier (worldwide) has been too high for almost 20 years. That means way too much money was created without proper leverage (or counterleverage - i.e. capital basis). This FED spread (i.e. “risk”) tells us that. That risk was valued way too low for almost 15 of those years due to the false sense of security the Default Swaps provided the market.
Now risk is valued very high (i.e. TED spread & other factors). This is a very natural market reaction. The market it attempting to flush out the money that shouldn’t have been there in the first pace. Of course when you go to an extreme in money creation, you will hit another extreme in destruction. We are seeing that.
Bottom line is our government should not fight this reaction (it will make it worse).
Value will now be reassesed and placed on the market - certainly more properly (look at housing price in Watts/Compton - housing sitll over $250,00 and approaching $500,000!!). And then we will stop overpaying.
Both ways (goverment interference or not) will be painful for us all. However if our govement keeps lending stardards too low - the pain will drag on much longer.
By Pat on Oct 12, 2008