The global impact of US$350 trillion in loans
THE London Interbank Offered Rate (Libor) has been around a long time. However, for many people who didn’t even previously know about it, it’s now of the utmost importance. Interest rates on more than a half of ordinary mortgages in the United States are linked to Libor. Every financial director anywhere worldwide knows what Libor is and how serious the impact of the past month’s sharp increase in that interest rate can be.
Bankers globally have known for a long time that Libor is much more important than the so-called repo rate of central banks that economists are so fond of speculating about.
Libor is set daily by the British Bankers’ Association (www.bba.org.uk), after they obtain the interest rates from 16 of the world’s leading banks. In brief, Libor is the rate at which banks are prepared to lend money to one another. It also serves as the reference rate for as much as US$350 trillion of loans and financial transactions with individuals, from mortgages to student loans right up to the biggest companies and countries’ sovereign loans.
All those entities borrow at Libor plus a certain margin. SA’s Government could recently borrow money at Libor plus around 100 points (that’s one percentage point). Until not long ago, the ordinary South African company could borrow money on the international market at Libor plus 150 to 200 points.
But then the market shrank and nobody was interested in lending money any more. Not even to the best and safest names. The graph shows the overnight Libor rates for most of September were merely a sedate figure of not more than 2%/year.
Then, suddenly – on Tuesday, 16 September – they rose sharply to 5%. That was the first working day after the infamous Black Monday – 15 September – in the US. That’s the day when Lehman Brothers, one of the biggest investment banks in the US, collapsed, and Merrill Lynch sold itself to the Bank of America for $50bn in an emergency deal.
Last week, when the US Congress voted by a small majority against the proposed $700bn bail-out, the world’s credit markets completely collapsed and the Libor overnight rate soared to an unprecedented 6,875%.
The overnight Libor rate has now dropped back to a more moderate 3,79%. However, the one- and three-month rates on virtually every currency for which the Libor rate is available are at new highs.
The one-month rate for the euro was still on 5,07% on Thursday last week, while the three-month rate on the US dollar was still a massive 4,15%. Most commercial loans to companies worldwide are done at the one-, three- or even 12-month Libor rate, plus of course the necessary margin. Banks are very fond of the so-called overnight loans among themselves.
US Treasury bills with a three-month term are currently trading at an interest rate of 0,73%/year. That’s right, the supposedly bankrupt US administration can borrow money for less than 1%/year. However, the Libor for three-month loans to the private sector – mainly the world’s leading banks and companies – is still a very high 4,15%. The difference of 342 points (that’s 3,42 percentage points) between what the private sector and the US Treasury have to pay for money is the so-called TED spread (Wikipedia says TED is an acronym formed from T-Bill and ED, the ticker symbol for the US dollar/euro interest rate).
The TED measures investors’ perception of risk. The higher the TED, the greater the banks consider the risk of lending money to other banks, no matter how big they are. The current TED spread is at record levels. It’s usually only about 20 or 30 points. Even at the beginning of the current sub-prime crisis in September last year, the TED rarely reached 150 points.
The TED spread – the risk barometer – is now almost 350 points and three-month interest rates at which the business world can borrow money for existing business and expansions is at the highest level in 10 years.
Have you ever wondered whether there’s a bit of a financial crisis in the world or whether economic growth – and also your wealth – will fall? Take a daily look at Libor and the TED spread. It’s guaranteed to disturb your sleep.