"Are Central Banks Making Libor WORSE?"

Equity analyst and market commentator James Bianco of Arbor Research e-maileda a discussion of the breakdown of interbank lending to us along with a few others, His note illustrates a point made by FT Alphaville a couple of weeks ago that we have harped on since, namely, that central banks’ efforts to provide liquidity to the money markets are not simply ineffective, but in fact counterproductive.

Bianco has put together a tidy and cogent analysis. He was looking for further insight and comment, so I hope readers with some perspective will speak up in comments.

From James Bianco (boldface his):

The Fed’s massive and numerous liquidity facilities are making things worse. The problem is more than banks unwilling to lend to each other, they are also unwilling to borrow from each other. Banks can get all the funding they need (and then some) from their central bank so they do not need to seek a loan from another bank. I believe it has gotten so bad that they don’t even bother to make a decent market for inter-bank loans anymore. No reason to, they don’t need them anymore as central banks have replaced them.

We can see this in the recent movement of 3-month USD Libor. See the following table.

It breaks down the 16 reporting banks for USD Libor during October. These banks are listed on the chart below the table. These 16 banks report their 3-month inter-bank lending rate to the British Bankers Association or BBA. The BBA calculates a Trimmed Mean by throwing out the four highest and lowest and averaging the eight in the middle (“Trim Mean” on the table below near the bottom). This is how they arrive at the Libor measure we anxiously await every morning (called “Posted Libor” in bold on the table below near the bottom).

Notice the huge spreads from bank to bank (see “range” in red near the bottom of the table). They suggest this is not a real market anymore. Real markets do not have this wide a variation. If it was a real market, these banks would have rates all similar to each other (click to enlarge).

To give you an idea of how the current variation between reporting banks is “off the charts”, see the following charts. Prior to August 2007, it was unusual if the variation between the highest and lowest reporting bank was more than 1 or 2 basis points. Now it is regularly above 100 bps. As we like to say, a number so big no one understands it (click to enlarge).

Too much central bank liquidity has destroyed the inter-bank lending market. This would be an “inside baseball” issue for the banking system except Libor is the benchmark for the “real economy” to get a loan. Libor is written into contracts and we have no good substitute. If Libor is screwed up, then the real economy pays because it needs Libor to get a loan.

This also means the market’s new favorite idea of having G7 countries guarantee all inter-bank loans will do nothing. If enacted, banks would still be missing an incentive to use the inter-bank loan market because they can get all the funding (loans) they need from their neighborhood central bank and at a much lower rate.

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  1. Anonymous


    Even if this is true, what’s the motivation for posting libor rates so much higher than central bank rates?

  2. Anonymous

    Doesn’t the bank have to report that data too? If they report back that they are paying more, they get more money kicked in by the central banks.

    Very interesting piece…

  3. Anonymous

    Singapore Don.
    Since the reporting banks have lots of assets priced off LIBOR, it makes sense for them to artificially mark LIBOR up. With deposit guarantees, they have their funding coming in very cheap from deposits, so the spread is huge. Although the BBA tries to ‘average’ the rates quoted, if all/most of the reporting banks may be playing this “lets mark it up to increase our interest margin” game. I think the problem is that LIBOR is a REPORTED rate, not an actual rate at which transactions happen. May be the regulators should lean on the reporting banks, all of whom seem to be relying on government largesse in one form or another, to stop these shinanigans.

  4. bg

    Your argument here seems to be:

    Interbank lending doesn’t exist, so Libor is a fictitious number. But since past-tense contracts are indexed off of Libor, then we have to get that number down by forcing banks to lend to each other?

    That is an absurd justification. If the US could invalidate the gold clause in 30’s contracts by fiat, they can do the same for Libor.

    The reason we need Banks to loan to each other is because governments do not have the plumbing to support the efficient distribution of capital to the economy. Otherwise we could just close the banks.

  5. Anonymous

    Are they borrowing from the cb’s and then lending to each other at inflated rates in order to suck some of the money out? If the cb’s are lending free, what is to stop me from taking that money and putting it to good use in the libor market?

    I might be more nice and call it arbitrage.

  6. john bougearel


    Jim makes a valid point. And it suggests to me that what Jim is indirectly saying is that the creation of all these lending facilities by central bankers have created conditions that have broken the LIBOR model or mechanism.

    And bg, yes, governments can shutter the LIBOR market, and require all lending be tied to some other short term rate.

    I wonder how feasible or disruptive a process like that would be

  7. Steve

    Do the funds brokers (Tullett, BGC, etc.) publish indices? At least that would be based on actual transactions.

    On the issue of artificially inflating LIBOR to pump up interest income: very unlikely, since each bank’s putative borrowing cost is published and no one likes to win the highest cost sweepstakes. Of course one can always imagine a price-fixing cabal but in the absence of evidence I’ll pass. The recent controversy was instead whether banks are understating their borrowing costs to appear healthier, and no concerted action is required for that.

  8. Anonymous

    This is good evidence that there is no “real market.” But just because there’s no “real market” (and even if there are no banks that want to borrow other than from a CB) does not mean that there are banks that want to lend. I’m quite convinced there are no banks who want more counterparty risk.

  9. Yves Smith

    To clarify, and I probably should have done so above:

    By all accounts, there is effectively no lending taking place in the interbank market beyond overnight. That is simply unheard of (absent a crisis like September 11 that leads to s short-term de facto market closure). The Bank of England said Friday that there are even signs of failure in the overnight market.

    The table above is for three month Libor. I would assume nothing is happening at the prices listed, they are indicative at best.

  10. Marcf

    Governments didn’t kill LIBOR, lack of trust killed LIBOR.

    Governments have to step in to provide liquidity. So bank liquidity is indexed on the source (gov) and not on the inter-bank liquidity which is dead.

    The economy bears the brunt of an artificial cost unrelated to the funding cost on the bank part.

    Blame the banks not the gov for shooting a dead horse in the head.

    Either the situation stabilizes or it doesn’t. If it doesn’t, you can bet there will be some flaws to force rewrite of the contracts. It is going to be messy.

    To blame central banks seems like a fallacious argument.

  11. Anonymous

    I completely understand what your saying. But what you are not saying is even more important. What do you suggest the US government do? If the basic problem is getting banks to lend to each other and other companies then what do you suggest? Im tired of people saying that whatever the government does is bad but not suggesting a solution. How can we get banks to lend? We restore confidence. Why dont we just insure all loans? Like the UK. This is a true solution. We can still take equity in banks and lend them money if need be. But forget ideology this needs to be solved.

  12. EvilHenryPaulson

    I’ve been over at CalculatedRisk discussions for this past exciting week, and I have brought this specific topic up many times when people have mentioned the TED spread or just LIBOR.

    The quoted article is spot on. LIBOR is high because the british banks can borrow all they want from the BoE. One Tuesday when LIBOR spiked up it meant nothing, no deals were being done at that rate.

    What happened was all the outstanding LIBOR + xx% loans started generating more revenue.

    They have no incentive to competitively bid LIBOR down because there is no net excess capital amongst them. We’ll have to wait and see for the next regulatory filings, but for British banks it is common to have 130% loans:deposits, so they have to borrow from banks in countries that have fewer loans than deposits (eg Japan, Canada, France…).

    Then due to the general credit crunch, there are many avenues for banks to lend at high rates in the short term outside of direct loans, look at commercial paper. Those alternate investments continue to offer high rates because even more money left that market to create a bubble in Treasuries — a very, very large amount of money to cause a bubble in treasuries dependent on continued appreciation.

    So you have the push, constrained supply of capital for LIBOR loans, and the pull, where the banks come in to take advantage of the very short term, elevated returns in alternate markets (the term is important because on any given weekend banks are aiming to be prepared for the next counter-party bankruptcy)

    Finally, one more consideration. Many banks offered loans at LIBOR + xx%, they would like to back out of those to free up capital. But since there have been no downgrades or other ways to exit the contract, they allow LIBOR to rise and force the weakest (and riskiest) borrowers to end the loan early.

    If you find it far fetched that there is collusion, or at the very least a common interest, to cause elevated LIBOR then do remember the BBA within the last year admitted that LIBOR had been incorrectly reported for years. The banks quoted lower rates than they offered in order to appear stronger, so when looking at a historical chart know that there is a step-shift in today’s LIBOR vs even 2 years ago.

    There isn’t much the government could do to force LIBOR down because it is just a symptom of de-leveraging and the only way to reconcile supply of credit (fundamentally decreased now, if for no other reason than regulatory lowering bank leverage ratios) with demand for credit, is for there to be bankruptcies amongst the debtors who are least able to survive with higher borrowing rates.

  13. Anonymous

    You’re wonderful, Ms. Smith. Keep printing the truth: government is choking us to death, because they are a one-trick con handing out free lunch.

  14. EvilHenryPaulson

    If you want to see an analogue for LIBOR, look at the Federal Reserve’s Commerical Paper report and take a long look at the A2/P2 yield curve.

    This is the most constrained part of the CP market. The rate is ~6% across the entire yield curve (while the rest of the market has been inverted recently, a story in itself). The rate being flat indicates that borrowers have been pushed out of the market beyond the 6% rate.

    One more note for capital constraints. In America the last $150bn 84-day, due Jan 2 next year after the year end squeeze, TAF they held had a bid:cover of 0.92. The stop out rate was like 1.39?%. That is a plain opportunity for banks to make money with as close to zero risk as possible.

    The only reason not to bid for the last $18bn was if they didn’t have the capital free which is stunning with the kinds of securities the Treasury will accept as collateral.

    Could someone who finds LIBOR being the equivalent of financial myth absurd please explain your thinking? I believe Yves agrees that whenever LIBOR is quoted high that actual transactions just stop. Mark-to-model interest rates are possible when you can circumvent the market on both ends and it loses competition.

  15. Richard Kline

    When the Fed and the BoE opened their repo windows in the low double digit billions, they are just one more node in the system. Their design was to lend at a penalty rate, but for reasons, not entirely irrational, this was reversed to below market rates, in effect a _bonus rate_. Still, their volume was too small to shift the systemic order; the idea and volume both a year ago were squarely to promote liquidity.

    When these CBs moved up to the high double digit billions on offer at ultra low rates it was a recognition that we were beyond a liquidity crisis and into a capital ‘problem,’ regardless of what was told to the public. Now, though, the volume of repos made the CBs much the dominant node in the financial system. So the system optimized around moving volume into the CB facilities at ultra low rates, and de-optimized around inter-nodal lending amongst its private participants. Now that the CBs are talking about paying interest on repos—in effect paying private parties to borrow public money rather than the reverse—the system will not only remain optimized around ‘window access,’ if will be completely frozen around such access. Why pay to borrow for each other when the CBs will pay _you_ to borrow from them?

    But this is a feature not a bug from the standpoint of the CBers, before considerations of secondary effects. Because the private banks are capital _busted_. The entire POINT of lending below market, and even more paying interest to borrowers, is to create massive spread opportunities for borrowing banks, so that they can lend at fat, FAT margins to the chumpen proletariat and real economy. EvilHenryPaulson at 3:19 details how this works with admirable clarity. The point, not entirely nefarious, is that this fat spread allows the busted private banks _to recapitalize themselves_, in the course of their normal business, at the expense of everyone else in the financial system. This is the same reasoning behind lowering policy rates. Banks get to borrow cheap from the Fed in the normal repo process and lend dear to the public.

    Now the public does get a secondary stimulative effect from the banks if and when they do lend in these conditions. And if banks were only getting a little lean and the fat spreads were quite transitory, this all is not quite as plutocratical as it sounds. But regardless, IT’S A STONE DUMBASSED AND MONDO INEFFICIENT WAY TO RECAPITALIZE MONEY-LOSING BANKS. And in present conditions, it won’t save the banking system because the capital losses at zombie banks are simply too great for them to recap a loan at a time, even with fat, manipulated spreads. How many years would it take with the facility windows open for the banks to get back in the money this way? What we have here is old insiders’ thinking in new, caustic times.

    —But all that is without considering secondary effects of optimizing flows in the financial system around facility access. I’m sure than Ben and Hank and their specialists never got this far in their thinking, because the spread-pumping was never intened conceptually to last for weeks and weeks, much less months and months. In effect, Ben and Hank are stuck at Plan A because they have no Plan B, secondary consequences be damned. Because CBs in the present system cannot build down facility volumes or workd back up toward penalty rates which in more normal circumstances would be exactly what they should be doing.

    So what to do? Admit that capital dead banks are systemic liabilities. Seize them, rework their capital with direct public fund injection for equity, which is a radically more efficient way to get bank for public buck. And while in control of those recaped banks direct them to loan to each other again, because they will not do this on their own.

    So that’s Plan D: Decap, recap, and handclap. Paulson won’t do it, so fire him and appoint someone who will.

  16. a

    I’m not sure the Fed is making things worse. What is true is there is no interbank market, and banks are pulling the numbers out of their a**es. So analysts who are looking at the TED spread and pontificating about how things are getting better or worse, are out of touch. *There is no interbank market*. None. The interbank market *can’t* get worse.

    Again, I’m not convinced that the Fed is the cause of this. If there were no Fed, then rather than the revival of the interbank market, I would just expect some banks to go under.

  17. Richard Kline

    Oh, I might add that giving banks access to the facility window without prohibiting them from paying dividends, seems criminal, but has a purpose. If the banks are to attract equity investment, they are going to have to pay dividends. If the goal is to recapitalize banks, then permitting dividends is a necessary component.

    Necessary, if the game is played the capitalists way. You see, all these ‘rules of the game’ operate in a system where the government dows not sieze problematic banks. If the government does not seize them, it _must_ help them soak the system, to save the system. If, however, the government simply seizes problematic banks, the public does have to pay, yes. In the case of individual banks in normal times, that may not be the way to go; more costly. In these trying times, seizing problematic banks is much the better way to go.

    We need to change the rules. Now, they are written by the banks, at the expense of the system and the public. To the cost of both. Time to save the banking system from itself.

  18. Greg Byshenk

    Richard Kline
    If the banks are to attract equity investment, they are going to have to pay dividends. If the goal is to recapitalize banks, then permitting dividends is a necessary component.

    But this is under the assumption that there is private capital willing to invest in the banks, even under current conditions in which investors cannot determine whether any given bank is actually solvent, which at least seems to be a counterfactual. While giving greater access to the facility window serves only to make it harder to determine whether a bank is actually solvent or not.

    Which means (if I am correct) that this cannot possibly work.

  19. Hedge Trader

    Whilst LIBOR rates may look like banks are no WILLING to lend to each other it is more likely that banks are simply NOT ABLE to lend. Visually it would be hard to tell the difference in market rates. Banks would not be able to lend if the cash raised from central banks from repoing low quality assets merely covered a deficit in their financing.

    At the same time central banks do indeed apear to be making the situation worse, driving the TED spread wider. In order to add liquidity central banks buys bonds (usually tbills) in the market, in return for cash. If its a liquidity injection its effectively a loan, if the Fed eases the liquidity added is permanent.

    However the banks hold very little in Treasuries these days as they hold credit instead. An idication of theis is the failed trades in the US government repo market which has recently hit over $3.5 TRILLION!

    Domestic fund managers also hold very little in Treasuries either. For example PIMCO hold no Treasuries at all in the Total Return Bond Fund. When the Fed buys Treasuries neither the banks or most mutual fund managers are able to sell their now expensive tbills for higher yielding cash or other credit bonds. The provision of liquidity is therefore ineffective for these firms as well.

    The Fed action does benefit some though, specifically foreign central banks which hold a lot of US Treasuries.

    The problem in money markets would be greatly eased if US banks sold their non government bonds for US Treasuries as Treasuries are zero weighted and other bonds are not (this includes good assets, not just the toxic stuff). By selling for Treasuries, capital ratios would improve and the action by the Fed would then start to work again.

    Until then the banking system will remain over leveraged, FED action will be ineffective and money market rates will continue to climb.

  20. Anonymous

    There are off course different types of libor and the bba quotes for overnight and 3 month rates in the euro sterling and the dollar currencies. I would expect with a government guarantee of interbank lending in the UK, 3 month sterling libor would drop if the reason was fear of counterparty failure. I remain unconvinced the raised libor is due to fear. The argument that central bank leading has replaced interbank lending has merit except that you can only borrow if you have good quality assets to post with the central bank. The rules on assets you can use at the central bank have devolved over time but I cannot see that it would replace all interbank lending. Another possibility is that banks are hoarding cash and I did think for a while CDS settlements may be a root cause for this. Maybe there is a reason why banks would not like to be seen to be borrowing. The most likely cause in my opinion for raised libor rates especially in the 3 month dollar rates is due to the fact that banks cannot lend because they cannot borrow enough money to meet existing lending commitments. This may reflect industrials pulling down credit lines put I think most likely reflects a downturn in revenue and a shrinking off the money source as investors move into treasuries.

  21. Richard Kline

    Yo Greg, yes, as of September 08, enticing in private equity is a dead startegy. In November 07 and February 08 when the repo facilities were ballooned, it was unlikely to work but not a wholly irrational approach.

    The larger point to me is that Bernanke and Paulson's plans are clever within the game as it was played pre-crisis, but too narrow for early in the crisis, and now largely dysfunctional at the deflection point in the crisis. In retrospect, the move to make would have been to throw the facilities open, as they did, and begin mandatory bank examinations to take failing banks into a public 'conservatorship'—i.e. public imposed mandates for dividens, pay, new best practices, etc., etc.—if not necessarily into outright receivership. The Fed may have lacked clear statutory authority for a half-way solution, so Bernanke may have felt, with some justice, that his hands were tied.

    OTOH, it is clearly unthinkable to Ben and Hank to nationalize banks, and even if others force them to think the unthinkable they have no vim or vision for it. —So Ben and Hank wasted their many months of opportunity whereby they could get out in front of the deleveraging in hoping that the old money games would suffice to recapitalize the banks. I don't know whether they were lied to by the industry or simply deluded themselves, but the scale of the financial system losses precluded and possibility of success by the Industry Preferred Solution. Especially when the industry, in my view, was playing a waiting game to get the Guvmint to buy MBSs up at inflated prices. What we have had for fifteen months is the Sharps leading the Marks, as the clock counted down to impact. We need new thinking, but it's clear we will need new thinkers to have such thoughts thunk in the halls of power.

    Yes, a significant portion of the freeze-up in lending into the real economy for normal business operations is a secondary consequence of the Fed & Tres strategy, in my view. The only way to get interbank lending going again, now that the system is frozen around facility access with many banks too weak to survive if cut off is to cull the worst, recap the lost, and show the rest the door back to their beloved market.

  22. wintermute

    Libor is NOT broken – it is central bank manipulation of interest rates which has caused the banks not to lend at Libor rates. In fact the single most important contributory factor to the credit crisis – is CB intervention in interest rates forcing them to be divergent from the true or “ideal” value. What is this ideal value of interest rates?

    The ideal value of an interest rate can only be set by the market because of the “calculation problem” identified by von Mises. Only the market can synthesise the opinion of millions of individuals, corporations and organisations who are phsyically lending and borrowing real money.

    CB “setting” of interest rates can only ever be an approximation of the ideal interest rate for a currency over a given term. Excluding factors such as political oil price shocks – the boom and bust economic cycle is largely caused by CBs having interest rates divergent from the ideal value too long.

    Why do CBs manipulate interest rates? Because governments typically run deficits and want to control how much interest they pay on the money they borrow. But the more indebted a government becomes the lower it forces interest rates – until, like Japan, it can no longer afford to move them to the ideal rate. This traps the economy in a decades long deflationary slump.

    The Rule of 72 gives a good idea where interest rates should normally be. The 4% to 6% range. This is because the number of years a lender requires to get a reasonable return on their money is in balance with the risk.

    So the Libor rate of 4.85% on Oct 10 is just about optimal for normal lending conditions in a stable economic environment.

    20 to 30 years ago CBs lost control of foreign exchange rates. In 2008 they have lost control of interest rates. CB acceptance of this would be the one good thing to come out of the credit crisis.

  23. AndyG

    You are all missing the point here.

    Banks have a vested interest in kepping LIBOR high because so many previously agreed commercial loans are priced at LIBOR +n%.

    The banks cannot change the terms of existing loans, so keeping LIBOR high now allows them to add the correct risk premia that was underpriced in the first place

  24. Anonymous

    I may be wrong, but could it be that banks are willingly not borrowing, precisely to make libor go up and extort, I mean extract as much money as possible from the real economy.

  25. Matt Dubuque

    Matt Dubuque

    One methodological concern I have about this analysis is that the way LIBOR is calculated each day differs DRAMATICALLY from the price discovery that occurs in the highly liquid Treasury market.

    LIBOR pricing is quite similar to what used to be the morning gold fix in London, wherein a select group of dealers provide quotes all based, to some material degree, on their narrow proprietary interests.

    So there are quite a few major market participants who state that LIBOR does not reflect the true state of the market at all.

    Many state that actually the state of the interbank market is much worse than is reflected in LIBOR quotes.

    I have also read some competent assertions from major players that LIBOR is portraying a WORSE picture than actually exists and that complaints to the contrary come from players with balance sheets that have more obvious and immediate issues.

    My point here is that Mr. Bianco’s conclusions are drawn strictly from one set of data points (LIBOR rates) that are clearly subject to errors and biases.

    Admittedly it is difficult to draw firm conclusions and LIBOR is a widely used and convenient metric. It is indeed the standard for this type of analysis.

    But my serious concerns about the non-transparency of this pricing mechanism nonetheless remain.

    Intermediation analyses based only on LIBOR clearly have substantial limitations.

    I came across a competent report that yesterday’s dramatic surge UPWARD in the NY bourse was due to an agreement being reached to change the way in which LIBOR is calculated so that it would more fairly reflect actual market pricing. I don’t know whether that is true, but the Fed has certainly been exploring alternative quotation systems, perhaps in an effort to compel the British to improve their methods.

    While I have not yet read Mr. Bianco’s work in full, I regard the quality of his work very highly. I just wanted to mention the methodological and statistical issues necessarily caused by the exclusive use of all data points from one source.

    On another note, I do have a concern that there may be a bit of “post hoc ergo propter hoc” going on here as well, i.e. that because one event FOLLOWS another, it is therefore CAUSED by it.

    Although I have not yet explored Mr. Bianco’s work in depth so as to evaluate it with this mind, I have noticed it in many analyses of central banking “errors” that exclude numerous other key factors in their analytical mix.

    Matt Dubuque

  26. john bougearel


    “Plan D” ~ love it. A dandy of a plan. Can”t wait to get started on them bank examinations of the banks to separate the hopeless from the salvageable.

    Maybe, just maybe, we need to send Hank and Ben to Sunday school to relearn the biblical story of separating the wheat from the chaff.

    Can they be that thick-headed, or just that frightened?

  27. Anonymous

    Higher risk has always implied higher overnight lending rates during crises — until central banks started intervening.

    Lowering short-term rates as risk rises is contrary to nature; a sort of financial auto-fellation. Why do they engage in this unseemly perversion? As Ricardo Kline said, it’s a backdoor way of generating fat spread earnings to the bleeding banking industry, which nominally OWNS the Fed. And also, in line with the Fed’s second (and often fatally contradictory) mandate to maintain full employment, it’s to stimulate the economy with cheap borrowing for Main Street.

    But both of these rationales are counterproductive to encouraging interbank lending during a crisis, by providing lenders with an attractive return commensurate with the elevated risks.

    Central banking is central planning. And like the Soviet central planners, the central bankers’ rate manipulation produces VALUE SUBTRACTION on a grand scale.

    Slashing the discount window rate during a crisis and then obsessing over the Grand Canyon dimensions of the LIBOR spread, is like pumping dry the Mississippi River during a 100-year flood, and then warning of a drinking water shortage. The gods are insane.

    — Juan Falcone

  28. Anonymous


    Good of you to take this one on in a posting.

    On the fixing:

    "A. An individual BBA LIBOR Contributor Panel Bank will contribute the rate at which it could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size".

    So each bank asks market how much do I need to pay you for a deposit with me ina variety of currencies and maturities.

    Libor in all quoted currencies began moving up around Sept 16th especially aggressively in the USD.
    We can guess that could be due to a demand spike a sudden supply restriction or neither of those but an increase in perceived risk.

    The spread widenings would be consistent I guess with attempts to price individual bank counterparty risk. To examine consistency one might look at divergence in CDS on these panel banks.


  29. Anonymous

    “U.S. Treasury Secretary Henry Paulson indicated that pumping government funds into banks is a priority and said financial markets will remain volatile.”

    What am I missing here? The article is about buying equities in the market -more manipulation of the market, not providing capital.

    Does the scheme go into the market to support share price to offer more shares to raise capital from the public? -simply more of the same dilution and leveraging?

    I believe the G8 discussion touched upon refusing the fiat of countries that continue to support fraud in the markets. No?

    Pumping up the stock market or individual shares couldn’t have relevancy to solutions required here. It defies common sense.

  30. FairEconomist

    I’m going to grind my little axe and say the problem in the 3-month LIBOR is at least partly due to the central banks “unbanking” money by borrowing at 3-month and lending overnight. Even the 84-day TAF isn’t quite an adequate substitute; the bank still will need about 6 more rollovers to make a 3-month duration. Right now I don’t think any bank can be certain it will win the overnight auctions in the future. What if the central banks pull back? What if there’s a massive crunch? And these auctions are after the end-of-year, which entail an unknowable but not trivial risk that the world financial system will have collapsed. So, I think, banks are playing it safe.

  31. Joyce Abraham

    We are headed for the worst week in the the stock market since 1970… Are we bottoming… or is there a waterfall ahead of us? What do you think?? I am a retired senior and a member of Myinvestorsplace.com and one of many looking for solutions. Any suggestions? Thanks

  32. Anonymous

    Somebody smart, explain to me this…

    What prevent bansk to just get Paulson’s cheap money, putting a hedge into some bad investment, selling the bad investment paper, then short the investment once it is on Paulson’s hand.

    USING Paulson’s cheap money!!

    The easiet money there is!!

    I know I would do it.

  33. Anonymous

    “Are we bottoming… or is there a waterfall ahead of us?” — joyce abraham

    Nobody knows. Even the best traders have only a slight edge — they may be right 55% of the time, instead of the 50% batting average that you or I could expect. But they will still be wrong 45% of the time.

    My opinion: the market probably will set a short-term low in the next few days … which could be another 10% to 20% down from here. The fear level is extreme, and such high anxiety is usually unsustainable for very long.

    Surprisingly, though, in terms of time-tested valuation indicators such as dividend yield, stock indexes are still slightly on the high side of average valuation. They are not particularly cheap. They do not offer compelling value yet, except for the short-term trader with nerves of steel who’s willing to step in front of a runaway freight train and “buy the crash.” This can be tremendously rewarding, if you don’t get wiped out attempting it.

    Also, the authorities haven’t even acknowledged yet that we’re in recession (although we are). The market leads the economy, but the economic statistics lag. The news background is going to be dismal for at least the next year, maybe two years. If it will bother you to own shares when the mass media is crying doom, maybe stocks are not for you.

    You might consider a partial allocation to stocks — not all of your capital. Plus some gold or gold stocks (not too large a percentage, because they’re volatile) as a hedge against a probable dollar crisis. Some fixed income — now that Fannie and Freddie are wards of the state, why not go for the higher yields available on their bonds? Are rental houses cheap in your neighborhood yet?

    The disconcerting fact is, that there is no all-knowing expert who can tell you with certainty what to do to make your portfilio grow and provide safe income. Ultimately you have to decide for yourself on a handful of diversified choices that make sense to you, and are in line with your risk tolerance. Good luck.

  34. Anonymous

    if commercial paper is the current problem, set up a fed desk in every bank in the US and use the 700b to lend direct

  35. Dave Raithel

    Mr. Kline and others in his exchange: I guess the point comes to this – If the CB’s cannot get banks to resume inter-bank lending with punitive policies, and if CB’s cannot get banks to resume inter-bank lending with beneficial policies, then what OTHER realistic alternatives remain but some kind of forced reconstruction taking cues from the Swedish model, the Galbreath plan, etc?

  36. wintermute

    Matt – so much for “price discovery in the highly liquid treasury market”.

    Bloomberg reports: “Treasuries have fallen the past four days even as stocks sank, a sign investors are preparing for bigger U.S. government borrowing. Benchmark 10-year note yields rose to 3.82 percent at 7:49 a.m. in New York, from a close of 3.45 percent Oct. 6”.

    That yield of 3.82% is much closer to Libor than the ineffectual Fed Funds rate of 1.5% Who does the Fed think they are kidding now? The “official” price of money has become a masquerade and the difference now is that, like what happened to the Wizard of Oz, the curtain has been pulled so everyone knows it is a joke.

  37. Matt Dubuque

    I think my chief concern about using the quotes from individual banks used to construct LIBOR to draw definitive conclusions about the wisdom of Fed policy is very much of a stretch.

    In summary, depending on their books, banks have perverse incentives to make quotes for LIBOR that are BOTH above AND below their actual cost of interbank credit.

    It’s just not a credible system for pricing, not at all transparent, not based on actual markets.

    It’s far more like the London gold fix, which was proved to be a rather noisy indicator of the actual state of the underlying market.


  38. Matt Dubuque


    There are quite a few errors in your reasoning.

    First, the claim that Treasuries sank because investors prepared for larger US government borrowing is dramatically oversimplified. There was also some improvement in the CP and RP markets that caused spreaders to move out of Treasuries and INTO those markets.

    A material (NOT all) part of the surge in Treasuries has been a panic to safety.

    So it is NOT necessarily catastrophic to see small, short term drops in Treasuries as panic recedes somewhat.

    Don’t believe everything you read on Bloomberg.

    In terms of the term structure steepening, that remains consistent with an accommodative stance managing the risk of a deflationary burst.

    Are you advocating a SHARP RISE in the Fed funds target for the Fed Monday morning?

    Perhaps a GLOBAL coordinated interest rate rise of 200 basis points to come into line with your daily data point from Bloomberg?

    Would such a coordinated interest rate rise by the central banks net out to ZERO effect on the panic in the markets?

    You are fighting the wrong war.

    DEFLATION is the threat, and HYPERDEFLATION (defined as a collapse in consumer prices at 7% per month) is a far greater threat than the hyperinflation bogeyman.


  39. ira

    forgive my naivete, but shouldn’t a decrease in demand (ie, no one wishing to borrow)result in a decrease in price (ie, lower LIBOR rate)

    an explanation would be greatly appreciated

  40. Bo Peng

    I posted an article on SeekingAlpha on 10/6 criticizing the injection of liquidity as opposed to capital:

    And then again on the same topic on 10/7:

    Glad to see Paulson’s got the point now and addressing the capital issue. Fed may have been useful as a temporary remedy on the symptom. But now Bernanke is causing too much problem.

  41. Anonymous

    so is central bank lending in lieu of libor sustainable? insofar as US is concerned, how much does the US Fed have left to loan on its balance sheet, or is its balance sheet just automatically increased? does the increase in fed fails mean anything? No activity in temporary open market operations Thursday and Friday, 10/9 and 10/10. Does that mean anything at all?
    Stuff I never thought I would ever want to know.
    this stuff is pretty arcane to a hick like me, but the law of unintended consequences seems to about the only thing we can count on anymore. And I’m not sure that our leaders understand this much better than lil ole me.

  42. Richard Kline

    So Juan Falcone, I am in agreement with you on the inappropriateness of the Fed’s policy rate easing in the last year, especially it’s scale. Now, this was SOP for the Fed, and so they resorted to normal methods to widen spreads. But in this case, this was counterproductive due to the actual capital positions of many banks. I went through the summaries above that I did because to me they document that even now the Fed and the Treasury are _unable_ to think effectively outside of the parameter set they built for themselves in the last generation, and the consequences of that cognitive shortfall are wider dysfunction. This isn’t surprising; I’m not sure that I even condemn anyone, but it is evident and very worrisome.

    So FairEconomist, I’m in total agreement that the Fed’s overnight lending has created severe term problems for banks. I didn’t try to parse this myself since I don’t feel I’m sufficiently informed on the details to have a firm read on what gives. Anything you are inclined to put up with detailed current content will have my attention.

    . . . So the obvious conclusion is that the Fed needs to move away from overnight repos to longer term. But how? And to what parts of the system?? One notion that I’ve been kicking around in the back of my brainpan has to do with the money markets. The markets for CP are absolutely critical to the real economy, but are severely impacted by the credit freeze. Money markets buy most CP, and to do so they borrow money from banks, but with banks frozen up there is no money to borrow on the open market. There has been talk of the government guaranteeing CP; this may be necessary, but does nothing to address the term mismatches systemically ‘broadcast’ from the effects of overnight Fed action. Nor would a guarantee make it possible for capital dead banks to lend, since they do not have the cash. —But the money markets are the actual buyers of the large bulk of CP, and they are the ones in the best positions to know which commericial paper issues are sound or not. Sooo it might make sense for the government to lend in 30-day and 90-day terms in volume _to the money markets_ so that the term match was right for CP to function. In other words, just work around the frozen up banks by lending to money markets directecly in the right term (of course while recapitalizing the banks concurrently). This doesn’t resolve the term mismatches at the bank level, but I leave it to others to make proposals there.

    And Joyce Abraham, I am anything _but_ an equities oracle, but I do not see us at a bottom in equities. It has been said by other commentors here at NC that we have not yet seen genuine capitulation in the US markets, and I am also of this view. Friday’s late bounce is _counterindicative_ of capitulation. We stand to have at least one more severe down leg, though whether all at once or in a couple of chunks I have no opinion. Equities aren’t going to zero; numbergs in the 50% range off their highs would fit with historically comparable situations. That doesn’t preclude further extensive declines over the next three-five years, however. We aren’t there yet.

    It would make a deal of sense for the US authorities to close the markets on Monday, but I doubt that they have the guts. Their thinking is so ‘inside business as usual’ that they don’t get it that we have a different problem set. They are beginning to get it; that’s why they are so scared. But the don’t get it above the neck, just in the gut. . . . Oh well, you go to Hell with the leadership you’ve got.

  43. Francois

    Since banks are becoming addicted to cheap borrowing from the CBs, the solution should be obvious.

    CBs notify the banks that they will gradually raise their rates until banks have to lend to each other. As long as the process is predictable and well anticipated by the Markets, what would be the problem?

    As for the pesky problem of “we don’t know where and who has how much in bad assets”, well, gubmints across the world will have to stop playing cheap asshat politics, send their SWAT teams pay a visit to the banks and peel the books until everyone is clean.
    Those who can’t survive go trough the cleansing fire of receivership, stockholders and bondholders get it in the kahunas, which is the normal market solution for bad bets turned wrong: Got to love the smell of capitalism in the morning.

    Finally, vulture investors put their capital to work knowing they’re not biding for a explosive device. Furthermore, banks can resume their normal activities.

    Anyone holding his/her breath?

  44. Anonymous

    Nice article Yves. Do you know of a daily source for the second graph, or was it hand-made?

    Rather than rewrite contracts citing Libor, would one solution be to merely redefine it? Just tell the BBA that LIBOR shall be defined as base rate + 100bps for the next 6 months or until such time as the spread would “naturally” be under 100bps?

    I imagine it would help if the panel didn’t use so many basket cases – perhaps banks could be excluded if their CDS was over x bps? So get rid of the likes of HBOS who aren’t going to be doing any lending in the foreseeable, and bring in some Asian/Gulf banks who actually have cash to lend?

  45. Gloomster

    Excellent article.

    Is LIBOR dying, then? The purpose of inter-bank lending seems to be dying, that’s for sure. If LIBOR has come to represent lending at commercial bank CDS spreads, then what non-financial institution would want to be linked to it?

    This article on the FT site points out that banks are lending to corporates now explicitly based on their CDS spreads. So why would a corporation be interested in a LIBOR swap, then? They’d want a swap based on, say, fed-funds or other government short-term debt rates.

    It could be seen as a huge opportunity for an enterprising bank to invent some new products.

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