Night­mare statis­tics

The global im­pact of US$350 tril­lion in loans

Finweek English Edition - - Openers - VIC DE KLERK

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 (, 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.

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