Credit Crisis Hitting LIBOR Rates

A: As Eurobanks fear the credit crisis, LIBOR rates (rates that Euro banks offer each other overnight), continue to rise. In short, when you see these overnight lending rates RISE at a time when the fed is cutting rates and bond yields are falling fast, it is a clear sign of distress in the credit markets. You can choose to wake up and acknowledge this so you can adapt, or you can look away. While I understand that discussing LIBOR will not tell you whether that apartment in Murray Hill is a good buy or not, it is important to understanding what a credit crisis is and how this will effect all asset classes. That in itself is far more important for any investment in my mind.

Lets take a big picture viewpoint for a moment. What is going on? Well, we are probably in the 3rd or 4th inning of a vicious credit crisis that is now making headlines and affecting investor confidence as consumers 'wake up' to this new world. Its not just here in the US, as the credit bug is spreading into Europe also. So with all this happening, and those in the know that read this blog will probably agree with this, it's safe to say that we probably have a few more rate cuts ahead of us as the fed uses its only weapon to help slow the total effect this credit crisis will have on the US economy; inflation will be second priority after growth.

With that said, lets look at this very interesting chart that I found on Global-View.com. Before you get un-interested because it looks like a complex chart, it isn't! Just bear with me for a second so I can explain it. The chart shows the current three month libor rate (blue-dotted line), the current Fed funds target (red-dotted line) and where the futures markets are currently trading three month rates for the specified periods in the future. The chart also includes comparisons of where these futures rates were trading most recently, a week ago and four weeks ago. The chart provides a view on where the markets feel U.S. interest rates are headed. There are 2 main points I want you to take from this chart.

The Big Picture: Take a look at the trend of the lines on this chart looking into the future! Those are market expectations as to where US interest rates are likely headed going as far out as 1 year from now. It's clear the market expects a troubling 2008 and a fed that will be forced to cut rates as they attempt to sooth the economic pain. However, in this world of re-priced risk, lower fed funds rate DOES NOT mean lower lending rates; at least the relationship is not as direct anymore! Expect lending rates to remain at higher levels as mortgage risk gets more out of favor.

LIBOR vs FED FUNDS RATE: I extended the MONTH AGO maroon colored line across the chart so we can use that to see where 3-MONTH LIBOR rates & FED FUNDS rates have gone over the past 30 days! I added arrows on this MONTH AGO line to show you that while fed funds rates have gone lower (with our fed cutting rates a total of 75 basis points (3/4 pt), LIBOR rates have actually gone up!

THIS IS A SIGNAL OF DISTRESS IN THE CREDIT MARKETS AS BANKS RAISE THE COSTS OF BORROWING TO EACH OTHER ON THE OVERNIGHT RATE!

This is also the rate that many adjustable rate mortgages and credit card rates adjust to! Some adjust to the 1-MTH LIBOR rate while others adjust to 1-YR LIBOR rate. Why do I discuss this? Just look at the web definition of LIBOR rate as stated by Bankrate.com:

It's an index that is used to set the cost of various variable-rate loans. Lenders use such an index, which varies, to adjust interest rates as economic conditions change. They then add a certain number of percentage points called a margin, which doesn't vary, to the index to establish the interest rate you must pay. When this index goes up, interest rates on any loans tied to it also go up. Although it is increasingly used for consumer loans, it has traditionally been a reference figure for corporate financial transactions.

With record ARM's set to adjust over the next 6-12 months, you should start to see why this is important. Lets hit some fresh news to back up what I discussed here, and you can see why I think these fundamentals are causing a change in confidence amongst foreign investors for Manhattan real estate, even as the US dollar continues its fall against the Euro.

Euro LIBOR Rates Up Again, Reflect Tensions... (Reuters UK)

London interbank offered rates for two-month euro deposits rose to new six and a half-year highs on Monday and three-month euro rates rose for the ninth straight session on persistent concerns over banks' year-end funding. The shrinkage in the asset backed commercial paper market is forcing banks to turn to Libor based funding, while supply of period funding is lower as banks hoard cash as a contingency against credit-related losses.

UK 3-MTH Overnight Libor Rises Again... (Forbes)

The cost of borrowing between banks in the UK rose again on a three-month basis as concerns increased over funding in the financial sector ahead of the New Year period. The London Interbank Offered Rate (LIBOR) rose to 6.53 pct from 6.52 pct yesterday for the three-month contract. This is still the highest rate since Sept 19.

LIBOR Soars As Credit Crunch Returns (Telegraph)

The credit crunch is returning in a virulent form to money markets, experts warned, after City banks raised their wholesale lending rates to the highest level in two months. Morgan Stanley said that the recent jump in the benchmark London Interbank Offered Rate, which yesterday rose to just under 6.45pc, was not merely a seasonal blip but a major warning sign of pain ahead. It came amid further jitters in the banking sector, where many smaller, more indebted banks are struggling to find lenders to keep them afloat. Libor rates, which indicate how willing banks are to lend to each other, have risen sharply during the past week, after spending almost two months close to the 6.3pc level - a worrying sign since it was Libor's increase in August that signalled the initial impact of the credit crunch.