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Wednesday, April 16, 2008

LIBOR Unreliable?

by Calculated Risk on 4/16/2008 11:00:00 AM

There is an article this morning in the WSJ suggesting that the LIBOR rate might be too low, possibly because banks don't want to reveal their actual borrowing costs. See: Bankers Cast Doubt On Key Rate Amid Crisis

Here is a description of the LIBOR from the BBA:

Libor stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from each other, in marketable size, in the London interbank market.
The WSJ article suggests that banks are actually borrowing at a slightly higher rate (one estimate is 0.3% higher), but reporting a lower rate to the BBA. This doesn't make much sense to me, since understating their borrowing costs would reduce the banks net interest margin.

The article offers two possible explanations for a manipulated rate: reputation to the bank (banks reporting higher borrowing costs might see a bank run), and banks might be earning more profits from derivatives transactions. Neither seems convincing, but it is possible.

Other measures of the liquidity crisis are definitely showing the third wave is not over.

Third Wave of CrisisThe TED Spread from Bloomberg:

The TED spread has increased to 1.62%.

Note: the TED spread is the difference between the three month T-bill and the LIBOR interest rate. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries).