This post first appeared on Minyanville.
You can't say they didn't try.
Nevertheless, the Federal Reserve's drastic moves aimed at jumpstarting lending, highlighted by dropping interest rates to nil yesterday, just aren't working. To be sure, conditions are better than they were just months ago during the height of the financial panic, but a normally functioning credit market is likely still months away.
Bloomberg reports banks are still hoarding cash and shunning loans from their counterparts around the world, preferring instead to borrow from the Fed directly. The interbank lending markets are basically nonexistent.
The spread between LIBOR -- the London Interbank Offer Rate, which measures what big banks like JPMorgan (JPM), Bank of America (BAC) and Citigroup (C) charge one another for loans -- and Treasury bills still 6 times wider than it was last June.
Companies, specifcally ones with less-than-stellar credit ratings, are paying record amounts to borrow from skittish bond investors. In fact, never before have buyers of corporate debt demanded more yield on their investments, according to data compiled by Bloomberg.
As Minyanville's Kevin Depew is apt to say, back on Main Street, everyday Americans "are getting shot from both sides."
Each time the Fed lowers interest rates, savers earn less on the money they sock away in the bank. This, combined with our ballooning national debt and struggling economy, are torpedoing the dollar, which has a punitive effect on those responsible enough to shy away from immediately parting with every penny they earn.
Washington is sending a clear message that the only way out of this mess is precisely what got us here in the first place: More spending. By providing paltry returns on savings and continuing to debase the currency, regulators and lawmakers alike are punishing responsible, conservative economic actions.
The trouble -- and why these fantastic efforts to rain money down on our broken economy will ultimately fail -- is that years of robust spending were driven by free and easy access to credit. Artificially low interest rates, loose lending guidelines, and a social mood that fostered spend-happy trips to the mall are a thing of the past.
Try though they may, bureaucrats cannot squeeze blood from the proverbial turnip. They spent the past 20 years hammering away at it, until finally the poor root couldn't take any more. It rolled over, returning to its shallow hole in the earth, to wait for brighter days.
The American consumer has followed suit.
Showing posts with label libor. Show all posts
Showing posts with label libor. Show all posts
Wednesday, December 17, 2008
Monday, September 29, 2008
Investors Flee Commercial Paper Markets
This post first appeared on Minyanville.
The bailout of the financial system has officially become a typical Washington dog-and-pony show. Partisan politics, it turns out, do in fact trump economic expediency and our elected officials' desire to act in the best interests of their constituency.
Meanwhile, back in reality, the short-term money market -- the oil that greases the gears of the financial system -- is coagulating.
According to the Wall Street Journal, cash is flowing out of the commercial paper market at an alarming rate. In the past two weeks, the market contracted by $113 billion, the largest amount since last summer when the Federal Reserve was forced to take unprecedented steps to unfreeze credit markets.
Companies use commercial paper investments to squeeze a little extra return out of cash they have lying around on their balance sheets. These securities, which typically last a few days or weeks, yield more than traditional money market accounts and were once considered nearly as safe as cash.
Proceeds are then lent out to companies that don’t keep much cash on hand and need to take out short term loans to fund their day-to-day operations.
The seizing up of these markets is affecting businesses large and small.
The Journal notes that payroll processor Paychex (PAYX), which relies on vast pools of liquidity to distribute paychecks for 500,000 American companies, is moving working capital into more secure instruments, some backed by the now nationalized Fannie Mae (FNM) and Freddie Mac (FRE).
Small businesses, on the other hand, that rely on short term loans to bridge the gap between cash outlays and payment for services are having to tap more expensive long term debt.
The cost of many of these loans is tied to the London interbank offer rate, or LIBOR, which remains at record highs. LIBOR represents the amount banks pay to borrow from other banks, and when uncertainty and fear reach the levels we’re currently experiencing, trust all but evaporates. Institutions brave enough to lend charge heftily for their trouble, and the ripple effects can be felt throughout the economy as the lion’s share of interest rates on adjustable rate mortgages and other consumer debt are tied to LIBOR.
As most traders sat down for dinner last night, be it at their desk or in their dining room, news broke that Washington Mutual (WM) had finally succumbed to losses in its massive loan portfolio. JP Morgan (JPM), again the beneficiary of a government orchestrated bailout, snapped up the ailing thrift’s deposit base.
While the removal of one of the most injured players from the financial field is an inevitable step towards repairing our broken system, the fallout isn’t likely to make banks any more willing to part with their precious cash.
Investors hate the unknown, and Washington is currently doling out uncertainty in vast quantities. Markets remain on edge and clogged, with all hopes of becoming unstuck hinging on a bailout plan that’s looking less and less likely to play out as Wall Street had hoped.
The bailout of the financial system has officially become a typical Washington dog-and-pony show. Partisan politics, it turns out, do in fact trump economic expediency and our elected officials' desire to act in the best interests of their constituency.
Meanwhile, back in reality, the short-term money market -- the oil that greases the gears of the financial system -- is coagulating.
According to the Wall Street Journal, cash is flowing out of the commercial paper market at an alarming rate. In the past two weeks, the market contracted by $113 billion, the largest amount since last summer when the Federal Reserve was forced to take unprecedented steps to unfreeze credit markets.
Companies use commercial paper investments to squeeze a little extra return out of cash they have lying around on their balance sheets. These securities, which typically last a few days or weeks, yield more than traditional money market accounts and were once considered nearly as safe as cash.
Proceeds are then lent out to companies that don’t keep much cash on hand and need to take out short term loans to fund their day-to-day operations.
The seizing up of these markets is affecting businesses large and small.
The Journal notes that payroll processor Paychex (PAYX), which relies on vast pools of liquidity to distribute paychecks for 500,000 American companies, is moving working capital into more secure instruments, some backed by the now nationalized Fannie Mae (FNM) and Freddie Mac (FRE).
Small businesses, on the other hand, that rely on short term loans to bridge the gap between cash outlays and payment for services are having to tap more expensive long term debt.
The cost of many of these loans is tied to the London interbank offer rate, or LIBOR, which remains at record highs. LIBOR represents the amount banks pay to borrow from other banks, and when uncertainty and fear reach the levels we’re currently experiencing, trust all but evaporates. Institutions brave enough to lend charge heftily for their trouble, and the ripple effects can be felt throughout the economy as the lion’s share of interest rates on adjustable rate mortgages and other consumer debt are tied to LIBOR.
As most traders sat down for dinner last night, be it at their desk or in their dining room, news broke that Washington Mutual (WM) had finally succumbed to losses in its massive loan portfolio. JP Morgan (JPM), again the beneficiary of a government orchestrated bailout, snapped up the ailing thrift’s deposit base.
While the removal of one of the most injured players from the financial field is an inevitable step towards repairing our broken system, the fallout isn’t likely to make banks any more willing to part with their precious cash.
Investors hate the unknown, and Washington is currently doling out uncertainty in vast quantities. Markets remain on edge and clogged, with all hopes of becoming unstuck hinging on a bailout plan that’s looking less and less likely to play out as Wall Street had hoped.
Thursday, September 25, 2008
Hedge Funds Hoard $600 Billion in Cash
This post first appeared on Minyanville.
While they’re not deviously plotting the demise of the worlds’ most powerful financial institutions, hedge funds are loading up on another popular trade: Cash.
According to the Financial Times, Citigroup estimates hedge funds have recently squirreled away as much as $600 billion in cash, of which $100 billion is held in money market funds - those same money market funds Washington so graciously propped up last week.
With good risk-reward investment opportunities in short supply, hedge funds -- paid handsomely to manage risk -- are relying heavily on the safety of cash to ride out recent market turmoil. It’s telling that for those whose livelihoods depend on beating the market, the investment du jour is no investment at all.
Money market funds, which offer a superior return to most traditional bank accounts, hold more than $3 trillion dollars for retail and institutional investors alike. The funds are offered by private wealth managers, as well as big financial institutions like JPMorgan (JPM), Charles Schwabb (SCHW) and even General Electric (GE).
Managers are supposed to invest in safe financial instruments that yield their clients a moderate but secure return. Since there's no chance for principal appreciation, funds compete on this return alone. During the credit boom, certain funds stretched for yield on the back of cheap leverage, investing in riskier and riskier assets, including the now-infamous mortgage-backed securities and other structured debt.
Last week, as if markets needed any more problems, the Reserve Primary Fund announced it had become only the second fund in history to “break the buck.” It turns out that in order to earn investors a higher yield, the fund had purchased debt backed by Lehman Brothers. When Lehman folded, the fund was forced to write off more than $785 million and halt redemptions as clients clamored for cash.
As uncertainty spread about which fund could be next, investors raced to withdraw money from what were feared to be the “next shoe.” That is, until the Treasury Department stepped in to prevent what could have been the bank run to end all bank runs.
Money markets don’t just act as a savings account on steroids; large financial institutions use them to maximize the cash they use to run day-to-day operations. Their willingness to sock away precious dollars at competing banks represents a healthy level of trust, that when they wake up in the morning the money will be right where they left it.
The past week has witnessed an evaporation of that trust, as banks are literally hoarding cash, forgoing returns in the interest of keeping their money close to home. Despite hopes the $700 billion bailout plan will defeat partisan politics in time to rescue the financial system, banks still won’t part with their cash. The recent spike in the London interbank offered rate, or Libor, is evidence of just how pervasive fear is.
Risk, as Mr. Practical is apt to say, is high.
While they’re not deviously plotting the demise of the worlds’ most powerful financial institutions, hedge funds are loading up on another popular trade: Cash.
According to the Financial Times, Citigroup estimates hedge funds have recently squirreled away as much as $600 billion in cash, of which $100 billion is held in money market funds - those same money market funds Washington so graciously propped up last week.
With good risk-reward investment opportunities in short supply, hedge funds -- paid handsomely to manage risk -- are relying heavily on the safety of cash to ride out recent market turmoil. It’s telling that for those whose livelihoods depend on beating the market, the investment du jour is no investment at all.
Money market funds, which offer a superior return to most traditional bank accounts, hold more than $3 trillion dollars for retail and institutional investors alike. The funds are offered by private wealth managers, as well as big financial institutions like JPMorgan (JPM), Charles Schwabb (SCHW) and even General Electric (GE).
Managers are supposed to invest in safe financial instruments that yield their clients a moderate but secure return. Since there's no chance for principal appreciation, funds compete on this return alone. During the credit boom, certain funds stretched for yield on the back of cheap leverage, investing in riskier and riskier assets, including the now-infamous mortgage-backed securities and other structured debt.
Last week, as if markets needed any more problems, the Reserve Primary Fund announced it had become only the second fund in history to “break the buck.” It turns out that in order to earn investors a higher yield, the fund had purchased debt backed by Lehman Brothers. When Lehman folded, the fund was forced to write off more than $785 million and halt redemptions as clients clamored for cash.
As uncertainty spread about which fund could be next, investors raced to withdraw money from what were feared to be the “next shoe.” That is, until the Treasury Department stepped in to prevent what could have been the bank run to end all bank runs.
Money markets don’t just act as a savings account on steroids; large financial institutions use them to maximize the cash they use to run day-to-day operations. Their willingness to sock away precious dollars at competing banks represents a healthy level of trust, that when they wake up in the morning the money will be right where they left it.
The past week has witnessed an evaporation of that trust, as banks are literally hoarding cash, forgoing returns in the interest of keeping their money close to home. Despite hopes the $700 billion bailout plan will defeat partisan politics in time to rescue the financial system, banks still won’t part with their cash. The recent spike in the London interbank offered rate, or Libor, is evidence of just how pervasive fear is.
Risk, as Mr. Practical is apt to say, is high.
Monday, August 4, 2008
Chrysler Debt Stalls Out
This post first appeared on Minyanville.
If you think it’s hard to find a car loan these days, try borrowing $30 billion to finance a whole fleet.
Chrysler Financial, the finance unit of privately-held Chrysler LLC, spent the last month in intense negotiations to renew short-term debt such as that used for leases, retail car loans and loans to dealerships.
According to The Wall Street Journal, the company only managed to scrounge up $24 billion - just 80% of the $30 billion it wanted. And the money it did find was expensive: The debt cost Chrysler 1.10% to 2.25% more than the London interbank offered rate (or Libor), as compared to a spread of just 0.30% to 0.50% last year.
Chrysler will likely be forced to pass the additional expense on to customers, making cheap car loans increasingly hard to find.
JPMorgan Chase (JPM), Citigroup (C) and Royal Bank of Scotland worked on behalf of Chysler to renegotiate the loans, but in the end 2 major dissenters wouldn't budge: Bank of America (BAC) and Credit Agricole failed to renew a combined $3 billion in commitments.
Bank of America is already up to its eyeballs in lousy car debt, since it helped lead the refinancing effort for GMAC, finance arm of embattled General Motors (GM).
The financing struggle illustrates not only the lingering effects of the credit crunch, but the extent to which certain big industrial companies are, in Toddo's words, “financials in drag.” Included in this list are fellow automaker Ford (F) and massive conglomerate General Electric (GE).
With cheap credit flowing through the financial system, management found it expedient to squeeze income out of balance sheets with aggressive money management. Whether it was tapping the now-collapsed auction-rate securities market or relying on sketchy consumer debt as a profit center (GMAC for GM and WMC Mortgage, a subprime lender, for GE), these so-called industrial behemoths relied heavily on their finance arms for profits.
For carmakers, sales have long depended on cheap and easy financing for would-be buyers. Now those loans are more expensive and harder to come by; revenues are sagging and losses are mounting.
These firms will have to find new ways to turn a profit, or figure out how to do it for less. Of course, that's something their customers are already being forced to do.
If you think it’s hard to find a car loan these days, try borrowing $30 billion to finance a whole fleet.
Chrysler Financial, the finance unit of privately-held Chrysler LLC, spent the last month in intense negotiations to renew short-term debt such as that used for leases, retail car loans and loans to dealerships.
According to The Wall Street Journal, the company only managed to scrounge up $24 billion - just 80% of the $30 billion it wanted. And the money it did find was expensive: The debt cost Chrysler 1.10% to 2.25% more than the London interbank offered rate (or Libor), as compared to a spread of just 0.30% to 0.50% last year.
Chrysler will likely be forced to pass the additional expense on to customers, making cheap car loans increasingly hard to find.
JPMorgan Chase (JPM), Citigroup (C) and Royal Bank of Scotland worked on behalf of Chysler to renegotiate the loans, but in the end 2 major dissenters wouldn't budge: Bank of America (BAC) and Credit Agricole failed to renew a combined $3 billion in commitments.
Bank of America is already up to its eyeballs in lousy car debt, since it helped lead the refinancing effort for GMAC, finance arm of embattled General Motors (GM).
The financing struggle illustrates not only the lingering effects of the credit crunch, but the extent to which certain big industrial companies are, in Toddo's words, “financials in drag.” Included in this list are fellow automaker Ford (F) and massive conglomerate General Electric (GE).
With cheap credit flowing through the financial system, management found it expedient to squeeze income out of balance sheets with aggressive money management. Whether it was tapping the now-collapsed auction-rate securities market or relying on sketchy consumer debt as a profit center (GMAC for GM and WMC Mortgage, a subprime lender, for GE), these so-called industrial behemoths relied heavily on their finance arms for profits.
For carmakers, sales have long depended on cheap and easy financing for would-be buyers. Now those loans are more expensive and harder to come by; revenues are sagging and losses are mounting.
These firms will have to find new ways to turn a profit, or figure out how to do it for less. Of course, that's something their customers are already being forced to do.
Tuesday, June 3, 2008
LIBOR On Shaky Ground
This post first appeared on Minyanville.
One upshot of the ongoing credit market turmoil has been a sharp increase in new acronyms added to the financial lexicon. The London Interbank Offer Rate, or LIBOR, is one such noteworthy addition.
LIBOR measures the rate at which banks lend to one another. When banks become skittish and seek higher return for additional risk, LIBOR goes up. Conversely, LIBOR moves downward when fear abates and lending loosens up. Depending on whom you ask, the rate is tied to $150-$350 trillion in financial assets.
In recent weeks, the integrity of the data collected to determine LIBOR has come into question. Banks were accused of misrepresenting their borrowing costs to contain fears the financial markets were unraveling. As the demise of Bear Stearns (BSC) proved, those concerns were warranted.
Each morning, the British Bankers' Association, or BBA, surveys 16 banks -- including Bank of America (BAC), JPMorgan (JPM) and HSBC (HBC) -- about their borrowing costs. It tabulates the results by tossing out the four highest and lowest values and taking the average of the remaining data points.
After weeks of deliberation over the alleged misrepresentations, the BBA announced Friday it wouldn't change its methodology. Bloomberg reports the BBA said it would "increase oversight" and called the issue "very serious."
That LIBOR's integrity has come under scrutiny is somewhat worrying. That an unregulated body responsible for the maintenance of the most widely used benchmark in finance can't be bothered to safeguard its practices is cause for outright alarm.
One expert told Bloomberg, "LIBOR is an inherently flawed index. [It's] an unresolved problem as it's not based on actual trades and actual borrowing costs but on people's guesses. Either it will die or it will change."
But the likelihood of LIBOR going away is slim. According to The Wall Street Journal,
in addition to the trillions of dollars in complex derivative investments based on the benchmark, $900 billion in subprime mortgages are tied to LIBOR.
If the myriad of failed mortgage bailouts has proved anything, it's the inability of the mortgage servicing industry to coordinate its way out of a paper bag. Servicers have the thankless job of collecting mortgage payments and chasing down borrowers if they don't send in checks.
It was fantasy to assume the industry could have affected such broad change with any degree of success. Even if regulators had concluded LIBOR's flaws were serious enough to warrant a switch to another benchmark, little could have been done. Any attempt to alter such a vast quantify of mortgages would be a disaster.
The financial markets are already crippled by mounting losses that don't appear to be abating. They now must creep along on a shaky foundation, one which fewer and fewer participants trust to weather even a mild storm. Landfall, indeed, will be a doozy.
One upshot of the ongoing credit market turmoil has been a sharp increase in new acronyms added to the financial lexicon. The London Interbank Offer Rate, or LIBOR, is one such noteworthy addition.
LIBOR measures the rate at which banks lend to one another. When banks become skittish and seek higher return for additional risk, LIBOR goes up. Conversely, LIBOR moves downward when fear abates and lending loosens up. Depending on whom you ask, the rate is tied to $150-$350 trillion in financial assets.
In recent weeks, the integrity of the data collected to determine LIBOR has come into question. Banks were accused of misrepresenting their borrowing costs to contain fears the financial markets were unraveling. As the demise of Bear Stearns (BSC) proved, those concerns were warranted.
Each morning, the British Bankers' Association, or BBA, surveys 16 banks -- including Bank of America (BAC), JPMorgan (JPM) and HSBC (HBC) -- about their borrowing costs. It tabulates the results by tossing out the four highest and lowest values and taking the average of the remaining data points.
After weeks of deliberation over the alleged misrepresentations, the BBA announced Friday it wouldn't change its methodology. Bloomberg reports the BBA said it would "increase oversight" and called the issue "very serious."
That LIBOR's integrity has come under scrutiny is somewhat worrying. That an unregulated body responsible for the maintenance of the most widely used benchmark in finance can't be bothered to safeguard its practices is cause for outright alarm.
One expert told Bloomberg, "LIBOR is an inherently flawed index. [It's] an unresolved problem as it's not based on actual trades and actual borrowing costs but on people's guesses. Either it will die or it will change."
But the likelihood of LIBOR going away is slim. According to The Wall Street Journal,
in addition to the trillions of dollars in complex derivative investments based on the benchmark, $900 billion in subprime mortgages are tied to LIBOR.
If the myriad of failed mortgage bailouts has proved anything, it's the inability of the mortgage servicing industry to coordinate its way out of a paper bag. Servicers have the thankless job of collecting mortgage payments and chasing down borrowers if they don't send in checks.
It was fantasy to assume the industry could have affected such broad change with any degree of success. Even if regulators had concluded LIBOR's flaws were serious enough to warrant a switch to another benchmark, little could have been done. Any attempt to alter such a vast quantify of mortgages would be a disaster.
The financial markets are already crippled by mounting losses that don't appear to be abating. They now must creep along on a shaky foundation, one which fewer and fewer participants trust to weather even a mild storm. Landfall, indeed, will be a doozy.
Thursday, April 17, 2008
Libor Pops on Transparency Fears
We noted this morning LIBOR's reliability has come under scrutiny as some traders fear banks are being less than truthful in reporting their borrowing costs. Now the Wall Street Journal is reporting the British Bankers' Association is accelerating its inquiry into the accuracy of data provided about bank-to-bank lending rates.
On Briefing.com, a report indicated "those in the know" claim fears about the integrity of LIBOR are groundless.Yet, the basis for which trillions of dollars in fixed income securities jumped today by the biggest amount since last August.
With a twist of irony, the gauge that monitors fear levels within the banking community is now reacting to fears about the reliability of its own data. This serves as a stark reminder of the systemic risks the credit crisis still poses to the financial system.
Earnings may beat sandbagged estimates, but risk, as Minyanville's Mr. Practical is apt to say, is high.
On Briefing.com, a report indicated "those in the know" claim fears about the integrity of LIBOR are groundless.Yet, the basis for which trillions of dollars in fixed income securities jumped today by the biggest amount since last August.
With a twist of irony, the gauge that monitors fear levels within the banking community is now reacting to fears about the reliability of its own data. This serves as a stark reminder of the systemic risks the credit crisis still poses to the financial system.
Earnings may beat sandbagged estimates, but risk, as Minyanville's Mr. Practical is apt to say, is high.
Libor's Integrity Called Into Question
The following post first appeared on Minyanville.
Scientific experiments use control factors as reference points from which all other measurements are taken. In the financial world, one of the most important of such constants is known as LIBOR, the London Interbank Offered Rate.
LIBOR measures the rate at which banks lend to one another. When banks become skittish and seek higher return for additional risk, LIBOR goes up. Conversely, LIBOR moves downward when fear abates and lending loosens up.
The spread (or difference) between LIBOR and virtually risk-free U.S. Treasuries measures the premium banks' demand to lend to other banks. In the past nine months, the spread between LIBOR and three-month Treasury yields has taken off.
Source: The Wall Street Journal
While many have argued the reasons and implications for LIBOR's wild swings, few have questioned the integrity of the data itself. Until now.
The Wall Street Journal reported yesterday that the group that oversees LIBOR, the British Bankers Association, or BBA, is starting to question the validity of the information it collects to determine each day's rate.
Each day, 16 of the world's largest banks, including Bank of America (BAC), JP Morgan (JPM) and HSBC (HBC), tell Reuters what it costs to borrow a "reasonable amount" in a designated currency. Reuters tosses out the highest and lowest quotes to negate the effect of outliers and arrives at an average bank-to-bank lending rate. The data is then disseminated around the world's financial markets.
LIBOR is used to set the terms of corporate debt, home loans, mortgage-backed securities and over $500 trillion in derivative contracts. It's the standard by which nearly all fixed income securities are measured. For example, subprime mortgages may cost a borrower 6.00% more than the LIBOR rate, whereas a well-capitalized corporation may pay only 0.50% above LIBOR on its highest rated debt.
According to The Journal's report, the BBA isn't sure its reporting banks are telling the truth. No specific allegations have been made, but some traders are concerned banks may be colluding or otherwise spreading misinformation to give the impression market conditions are better than they really are.
The implications -- if true -- are significant.
By some estimates, LIBOR may be underestimating the true cost of bank-to-bank borrowing by as much as 0.30%, a meaningful figure considering Tuesday's three-month Libor rate sat at just 2.72%.
The real losses stemming from a systemic adjustment to LIBOR would be trivial compared to the psychological effect such a correction would have on financial markets.
There's a growing belief the wider implications of the credit crunch, although extensive, can be quantified and priced into an individual stock or bond. We're now being told financial companies' share prices have so much bad news baked in, they can't conceivably go any lower.
This talk sounds comforting on the brink of recession and, according to some, the biggest financial crisis since the Great Depression. And while in the near term such a thesis may be true, any such assumption is purely speculation.
If LIBOR -- heretofore as reliable an index as the rising sun -- can't be accurately determined, the ability to reasonably value any asset is called into question. From the very top (LIBOR), to the very bottom (residential real estate), illiquidity and a lack of trust are rendering any concept of rational markets invalid.
Any analyst who proclaims financial companies are cheap, or have strong balance sheets, is at best taking a stab. If an index so universally accepted as LIBOR is called into question, what does that say about what the $70 billion in Level III assets sitting on Goldman Sachs' (GS)? Anyone proclaiming to know their actual value is simply guessing.
The concern over LIBOR may be nothing, or it may be the sort of issue that slowly turns from rumor into reality, not unlike recent events surrounding the collapse of Bear Stearns (BSC). But the fact that its integrity is even being called into question could mean banks are hiding something they really, really don't want anyone to know about.
Reprinted by Permission copy write 2008 Minyanville Publishing and Multimedia
Scientific experiments use control factors as reference points from which all other measurements are taken. In the financial world, one of the most important of such constants is known as LIBOR, the London Interbank Offered Rate.
LIBOR measures the rate at which banks lend to one another. When banks become skittish and seek higher return for additional risk, LIBOR goes up. Conversely, LIBOR moves downward when fear abates and lending loosens up.
The spread (or difference) between LIBOR and virtually risk-free U.S. Treasuries measures the premium banks' demand to lend to other banks. In the past nine months, the spread between LIBOR and three-month Treasury yields has taken off.
Source: The Wall Street Journal
While many have argued the reasons and implications for LIBOR's wild swings, few have questioned the integrity of the data itself. Until now.
The Wall Street Journal reported yesterday that the group that oversees LIBOR, the British Bankers Association, or BBA, is starting to question the validity of the information it collects to determine each day's rate.
Each day, 16 of the world's largest banks, including Bank of America (BAC), JP Morgan (JPM) and HSBC (HBC), tell Reuters what it costs to borrow a "reasonable amount" in a designated currency. Reuters tosses out the highest and lowest quotes to negate the effect of outliers and arrives at an average bank-to-bank lending rate. The data is then disseminated around the world's financial markets.
LIBOR is used to set the terms of corporate debt, home loans, mortgage-backed securities and over $500 trillion in derivative contracts. It's the standard by which nearly all fixed income securities are measured. For example, subprime mortgages may cost a borrower 6.00% more than the LIBOR rate, whereas a well-capitalized corporation may pay only 0.50% above LIBOR on its highest rated debt.
According to The Journal's report, the BBA isn't sure its reporting banks are telling the truth. No specific allegations have been made, but some traders are concerned banks may be colluding or otherwise spreading misinformation to give the impression market conditions are better than they really are.
The implications -- if true -- are significant.
By some estimates, LIBOR may be underestimating the true cost of bank-to-bank borrowing by as much as 0.30%, a meaningful figure considering Tuesday's three-month Libor rate sat at just 2.72%.
The real losses stemming from a systemic adjustment to LIBOR would be trivial compared to the psychological effect such a correction would have on financial markets.
There's a growing belief the wider implications of the credit crunch, although extensive, can be quantified and priced into an individual stock or bond. We're now being told financial companies' share prices have so much bad news baked in, they can't conceivably go any lower.
This talk sounds comforting on the brink of recession and, according to some, the biggest financial crisis since the Great Depression. And while in the near term such a thesis may be true, any such assumption is purely speculation.
If LIBOR -- heretofore as reliable an index as the rising sun -- can't be accurately determined, the ability to reasonably value any asset is called into question. From the very top (LIBOR), to the very bottom (residential real estate), illiquidity and a lack of trust are rendering any concept of rational markets invalid.
Any analyst who proclaims financial companies are cheap, or have strong balance sheets, is at best taking a stab. If an index so universally accepted as LIBOR is called into question, what does that say about what the $70 billion in Level III assets sitting on Goldman Sachs' (GS)? Anyone proclaiming to know their actual value is simply guessing.
The concern over LIBOR may be nothing, or it may be the sort of issue that slowly turns from rumor into reality, not unlike recent events surrounding the collapse of Bear Stearns (BSC). But the fact that its integrity is even being called into question could mean banks are hiding something they really, really don't want anyone to know about.
Reprinted by Permission copy write 2008 Minyanville Publishing and Multimedia
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