For some time I’ve been saying that interparty risk wasn’t why the LIBOR rate was so high. My point was that lending at close to Fed funds was a huge inflation haircut and banks could lend at better rates. Conjure has come out with a paper that suggests something different: that the LIBOR rate has become effectively fictional(pdf). Because banks can borrow from the Fed for so little and because the Fed has made huge amounts of liquidity available, there is no longer any need to borrow short-term from other banks.
The LIBOR is made up of rates submitted by 16 large banks every day, of what they say could borrow money at if they wanted to. In the past the variance between the rates they submitted was rarely more than a couple basis points, these days it’s often more than a 100 basis points. The explanation? In the past they were actually borrowing and the rate was about the same for each of them. Now they aren’t borrowing from each other and are just making the numbers up, or if you wish, estimating them.
LIBOR is used to price about 150 trillion in securities, including, among other things, variable rate mortgages in the US and credit card debt in the UK. So movements in LIBOR matter a lot. And at this point those movements may well be fictional.
Now, to think it through further, TED spreads – the spread between treasuries and LIBOR are a large part of what has had the central banks in a cold sweat panic for months now. Every time it spikes up they make more money available to banks, or insist on 700 billion dollars, or some such, in order to try and get it back down.
So: made up numbers and a benefit to keeping them high.
Not a good combo. Mind you, there is a real squeeze in short term money, you can see that by the troubles commercial paper has in being bought. So the fact that real lending money is tight is not a fiction. But LIBOR may well not be an accurate gauge of how tight it is and a new measure of short term inter-bank liquidity may be necessary. Certainly, policy driven by TED spreads needs to stop, since the numbers are most likely fake and manipulated.
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so i looked up libor after ian’s earlier post and i think i get that now. but what is ted? anyone?
Libor has always sucked. I don’t understand why anyone would borrow under their rules.
Ted is the difference between LIBOR and the treasury bond rate for the same duration.
Sixteen of those Tinkerbells? I love that they could just invent the interest rate that they felt like.
Maybe I’ll try that the next time I borrow money from the bank. I “feel” like you guys should give me x.
Digg this
actually, the reality is that unless you believe in some type of strong form market efficiency doctrine, all of the key money market instruments are proxies for the markets’ perception of reality rather than an effective indicator of underlying fundamentals.
True enough, though there are degrees of removal from reality/fundamentals.
ian, so how to reduce the spread between TED and LIBOR? is stopping it the only way?
are we could to have to redo the financial systems in order to get things moving again?
Dugg.
dugg and thanks eg
in terms of fundamentals.. I’m much more concerned about the following: the net worth of the median American household is now about $85,000. That household’s pro rata portion of the Federal debt is now $86,000. Whatever the money markets say, this pretty much means we’re screwed IMO. Well, at least the middle class, in the absence of either a radically progressive strategy for distribution our collective obligation for servicing that debt or unrealistically high rates of future income growth.
so explain what the LIBOR is…..
We have no choice but to hang tight. None. Love republicans, all?
Daily rates based on the Wall Street Journal’s cost of funds, far as I know.
Lending rates?
i read a wikipedia page on it earlier. it’s the london interbank offer rate. i think it said 12(?) major european banks come together on this number based on what they are willing to lend to one another at? hmmm, then again, here’s the wikipedia link:
http://en.wikipedia.org/wiki/LIBOR
Thanks everyone…… who would know that I had a minor in Business……
LIBOR is the rate banks charge lend money to each other.
It’s based in London; earlier this year the story broke that the Banks were making up the spreads they were reporting. Once the regulators forced the banks to report the real rates the LIBOR rates started to skyrocket.
Oh please! I took Statistics one summer – got a B (damn near an A) and can’t tell ya a damned thing that I learned in that 5 weeks.
No! I take that back, I do understand, mean, average, and that other one.
OT
Remember way back to the Democratic primaries and when Clinton and Obama were battling it out? I know, it seems like so long ago. One of the things that struck me was how exciting that race was. For the first time in history a woman or an African American would be the Democrat candidate for the Presidency of United States. Networks talking Dems, Dems, Dems month after month. After McCain won the GOP primary we didn’t hear much about him. Nothing about who his VP would be. No campaigning with his VP. I don’t even know where he was, out hoping to get campaign dollars maybe. I didn’t care. I just know he wasn’t in the news much. Obama, Clinton, Obama, Clinton every night on our tv’s, sometimes even Former Prez Clinton. TV talking heads saying Clinton should bow out. Yet here onfiredoglake I was reading how excited people were because their state finally mattered in a primary election. More people were interested in who the Democratic nominee would be than ever before. More people were signing up to be campaign workers in those later primary states because the nominee hadn’t been decided yet. Primary after primary we read this here. Some took the day off of work to go vote, some got babysitters because they knew the lines would be long, some stayed till the wee hours of the night to become delegates. Every time I heard the MSM say this wasn’t good for the Dem’s and Clinton should bow out I was thinking are you kidding me, this was the best thing that could happen to the Democratic party. We got motivated in a big way. We got motivated state by state in a big way. Our primaries counted. All Dem states primaries counted. As it should be. Even Guam, Puerto Rico and the US Virgin Islands were involved. When have we ever heard about these territories during a primary election? The day of a few states choosing who the candidate for their party was over. Never again. People from all the states came out voiced their opinion and voted in the Democratic primaries and we were held on the edge of our seats with suspense on who would win our nomination. We have more new registered voters than ever before. We had longer primaries that got more Democrats in more states involved than ever before. We have more excitement and enthusiasm than ever before. We turned out for the Democratic primaries in droves. People are coming out in the thousands to show their support for Senator Obama. 84,000 came out to see his Democratic nomination speech. We will also turn out Nov 4, 2008 for the Presidential election like never before. AND WE WILL VOTE FOR OBAMA. Make no mistake about that.
Variable.
where did everyone go?
Dugg it
yes we will. it seems media may prefer closer races to maintain interest/sales, but i am expecting a blowout. i know that sounds naive after 2000 and 2004 but for all those things you just mentioned, i believe we’re about to be on the good side of a drubbing.
i’m still here katymine
Dugg!
Me too, katymine.
Ian –
I love reading your posts. I’ve used your stuff on my blog so the other 3 people who read it can understand the economics of what’s going on.
word, i think i have said almost the exact same words here to ian in the past. that is pretty funny. i think of myself as a layperson who tries to translate this stuff down to my family and friends who only sometimes read my blog.
Sorry! As I said, film “Lives of Others” on starz — heartbreaking and why, it is what is happening here in the USA today, like East Germany.
I’m here too. I’m just tired…it’s an autumn thing. I get that sun deprivation thing and have to get another full-spectrum light bulb to deal with it. Have too much to do to be hibernating!
What has happened here is nothing short of theft. Obama knows it, as do all good democrats. They’ve stolen our wealth, and they need to pay us back. Criminal trials need to happen, and soon.
Time for the time change.
Margot, I spent this wonderful day inside, CLEANING, for hours…could kick myself for missing such a beautiful day.
late late nite upstairs
LIBOR is the rate that banks can borrow from each other at. Supposedly. 16 banks give the rates that they can lend at at different intervals, like overnight and three months, average those and that’s LIBOR.
Probably have to find something else to peg short term interest rates to. Not sure what, but it needs to be something where people are actually borrowing and lending.
Katymine your halucinating noone is hear…it is the rapture and Palin and froiend have taken everyone away…the magical mystery tour. And suddenly she awoke from the dream and all her bloger friends were surrounding her. And we all lived happiliy ever after.
Thanks Wordsmith.
Ian the spread was about 300 basis points this week. Who is that play for?
Remember TheraP’s essay on boundaries and ethics, Sarah Palin?
Check out Palin’s behavior in this video where she’s booed yesterday at the Phlly Flyers opening game.
It keeps up the pressure on central banks. For example, Freddie and Fannie will start buying up trash at 40 billion a month.
IIUC, this is exactly the point that ubetcaiam was making in the first paragraph of this diary: http://oxdown.firedoglake.com/diary/655
IMHO, the problem is not so much that banks aren’t loaning to each other, but that in the aggregate they aren’t lending to the non-banks, who are in need of cash to pay their workers and vendors. They aren’t borrowing from each other because the credit isn’t flowing to their customers.
I don’t buy the notion that it’s because of inflation; they make their money on the difference between interest rates. Inflation might diminish their profits but not make them disappear. Banks need to loan all the money they can get their hands on at whatever rate will make them a profit, the higher the better so long as the profit is positive.
there are better places to lend the money, that’s the point. And lending at less than the rate of inflation is a loss, it’s just less of a loss than not lending at all. They’ll do it if they have to, but if they have other options, they won’t.
But it’s not a loss for the bank, because they are lending OPM. They are paying x% for the funds they “borrow” from the fed and/or their depositors, and loan them at x+y%. Assuming y is a positive number, the bank makes y% in (possibly inflated) dollars. They are still making money. The only effect of inflation is that it diminishes the buying power of their profits.
For example, say that x=3% and y=2%. Say the bank loans $1000 for a year at x+y%, i.e., 5%, in a time of 10% inflation. They receive $1050 at the end of the year, give $30 to the fed and/or depositors, and pocket $20, which now has the buying power of what was $18 at the time of the loan. My point is that they did not lose money.
True enough.
Nonetheless they can lend for more, or they can keep cash equivalents on hand. And both, right now, are worth more than lending short. Cash is king right now, because you can snap up distressed companies and assets cheap. People were paying 8 cents for Lehman stuff. A lot of it was worth more than that, even I believe that and I’m a pessimist. A killing was made. The returns on that will be far more that 2 or 3 or 4%.
Right now you can lend long for more than inflation, or you can keep cash on hand for use buying stuff at cents on a dollar. Why should you lend short? And 3 months isn’t that short, really: if you’re not certain how bad things are going to go, you’ll probably just put it in treasuries, which can be used as cash, and sit on it.
But there is very strong resistance to lending below inflation. Brockway used to call it the “Bankers classic COLA” and bankers hate not getting their COLA, which is why traditionally Fed rates were alway set at inflation+ profit, so banks would always be profitable and want to lend.
So, are they really cash limited. I had gotten the impression that the Fed was so anxious to get the money flowing that banks now have access to a nearly unlimited supply of below inflation money to dole out. Right?
If bankers aren’t doing short-term loans it’s for some reason:
– lack of funds (i.e., higher yield allocation for limited funds)
– inability to determine risk on plentiful funds
– lack of demand (which we know isn’t the case).
Ian: One of the things I admire about FDL and it’s commenters, is a willingness to speak to truth about both presidential candidates.
To that point, I encountered a site, and for me, new and unsettling information about Obama.
In brief summation: Obama’s national campaign chair, Penny Pritzker, is one of the original developers of the sub-prime loan, through here ownership of a bank in Illinois. Eventually the bank went belly-up, taken over by the FDIC. She came out unscathed, and is now, with her family, a mult-billionaire (+10Billion-not chicken feed). And she is the money maker for the Obama campaign.
The point the blogger makes is that Obama, now is locked in to continuing the same basic fiscal policy (with some minor cosmetic changes), that will make the rich richer, because of his association with Pritzker.
the site is http://www.bestcyrano.org/THOMASPAINE/?p=1089
Food for thought Angry B
Actually, for some types of loans I think demand is down. It’s just that supply is down even more. I do think a lot of it is risk problems, not only new loans as much as risk for themselves (as things get worse, how much worse will thier position be? Many of them probably aren’t sure.)
I also think it’s hard to overstate the “cash is king” thing right now.
Ian, I left this comment at another site this weekend:
What do you think? I think we’re getting over our head if we try to figure out exactly what they’re doing. Let’s just not let them do anything because they can’t be trusted and don’t know what they’re doing. Let’s insist on new people to lead – people with a track record of being right.
LIBOR’s not fictional to the people who are required to pay much higher interest rates. It’s what happened after the savings and loan crisis. Banks gave depositors almost no interest and charged borrowers 5 to 10 percent more than they paid depositors. Depositors got less than the inflation rate and banks got a good deal more. I don’t think it will work this time since borrowers are tapped out and the economy is not strong enough to keep them floating.