Libor increase trumps Fed Rate reduction…?

[Rockemsock]

Here’s a comment posted by an anonymous poster on another housing blog. Your thoughts?

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Must Read Barbera Analysis:

LIBOR Increase Devastating

To this end, we see no hint that the credit default worries centering around CDO’s and infecting the ABCP market have abated. Instead, over the last two weeks, the spreads on London based Libor 3 month borrowing over Fed Funds have continued to widen out.
The widening yield spreads in recent days have been quite dramatic, and have served to strengthened overseas currencies. Yet the big downside risk ahead still resides in the US Credit Market where the long march of “resetting” adjustable rate mortgages has just begun. Looking out over the next 12 months, the US is facing a monumental series of ‘resets’ to its pile of Adjustable Rate Mortgages on the order of $50 to $60 Billion dollars per month, with some months north of $70 billion. In this light, the surge in recent weeks in overseas Libor Rates is potentially devastating news for the US Homeowner because within the US, increases on Adjustable Rate Mortgages are tied to the LIBOR Rate, and NOT the Fed Funds Rate. In fact, a recent article by Randall Forsyth in Barron’s pointed out that most resets will take place at several points ABOVE LIBOR. “This means that some of those borrowers may face mortgage rates of close to 10%, with the recent rise in Libor rates exacerbating this squeeze.” Consequently, even if the Fed lowers the Fed Funds rate by 25 basis points, the offsetting rise in Libor Rate imply that for most borrowers, there will be no benefit whatsoever.

[DaCounselor]

More often than not LIBOR will run close to the FFR, so I expect the current spread will shrink if/when the Fed eases. I doubt the current spread will remain for the long term, in any event.

As for mortgage rates close 10%, that would require a margin of 4.5 on the 6 month LIBOR. I suppose there may be margins out there like this but i believe it’s far more common to see margins in the 2.0 range, which equates to an interest rate of about 7.4% today. Big difference.

[drunkle]

if libor is a composite of the rates of central banks around the world, why would it parallel the ffr? other banks have been raising their rates, thereby pulling the libor up… with an ffr reduction, the libor may be pulled down, but surely not enough to offset international rates?

[DaCounselor]

“if libor is a composite of the rates of central banks around the world, why would it parallel the ffr?”
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i believe LIBOR is set by the BBA and is not a composite rates from around the globe.

i have not looked at LIBOR beyond ’99, but since then the 6 month LIBOR has mirrored the FFR. and i believe there is evidence that the 3 month LIBOR movement slightly pre-dates that of the FFR.

[drunkle]

found this:

http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=10692

[Anonymous]

First make sure your currency is USD (not EUR or Pound Sterling). Overnight LIBOR indeed is rather close to FFR, as banks have no reason to borrow at a higher rate if they can get FFR within the US interbank market. But 3 month LIBOR is indeed not budging, and this is a lot more meaningful as an indicator for credit cost than 3 month T-bills. However 3 month LIBOR should be capped by the Fed discount rate (which has been lowered to 5.75) since banks would be fools to borrow LIBOR at a higher rate. As Fed is unlikely to lower the discount rate again so yes the FFR action next week will be rather symbolic. And FFR has been practically at 5% for a while.

[Author]

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