Libor, set every morning in London, is what banks pay to borrow money from each other. That in turn determines prices for financial contracts valued at US$393 trillion as of Dec 31, 2007, or US$60,000 for every person in the world, and helps set consumer interest rates on everything from home loans to credit cards.
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Americans Grapple with Libor
Interest in a once obscure acronym is increasing as its impact on the economy is felt keenly and widely
4 October 2008
ANISHA Gupta, returning clothes to a Hugo Boss store on Rodeo Drive in Beverly Hills, shrugged when asked about Libor. She had heard the term. She wasn’t sure she could define it.
‘I thought it was a pill,’ said Ms Gupta, an unemployed 27- year-old who lives in downtown Los Angeles.
Americans are getting a crash course as a once obscure acronym weighs on the economy. In interviews across the country, oil workers, ministers, bank managers and politicians said they were baffled by the London interbank offered rate or fearful of its surge this week. They agreed Libor was important, even if they couldn’t put their finger on why.
‘Without getting real specific, I think I’m probably not competent to be talking about what is happening overseas,’ said Senator Jon Kyl, an Arizona Republican who helped shepherd passage of a US$700 billion bank bailout as his party’s No 2 official. ‘It’s all happening very rapidly.’
Libor, set every morning in London, is what banks pay to borrow money from each other. That in turn determines prices for financial contracts valued at US$393 trillion as of Dec 31, 2007, or US$60,000 for every person in the world, and helps set consumer interest rates on everything from home loans to credit cards.
In the past week, as governments in Europe rescued five banks and the US debated a bailout, the cost of one-month bank loans in euros and overnight dollar loans soared to records. In practice, that means banks are hoarding cash, raising borrowing costs and slowing economies worldwide.
Still, explaining Libor can be a challenge.
‘What you have been seeing in the destruction of Libor in the last months, I cannot really point to that point and say this has impact on car sales,’ said Fritz Henderson, the chief operating officer of General Motors, in a TV interview. ‘But certainly it is very destructive.’ The complexities showed during the bailout debate in Congress.
‘Very few Americans have ever heard of something called the Libor,’ said Senate Banking Committee chairman Christopher Dodd, a Connecticut Democrat, on Oct 1. He defined the term, then said, ‘Libor jumped over 400 per cent in just one day.’
Actually, overnight dollar loans rose 168 per cent on Sept 30, to a record 6.8 per cent from 2.6 per cent. Mr Dodd was probably referring to the increase in basis points, or hundredths of a percent, which was 431.
A spokesman at Mr Dodd’s office in Washington, who didn’t identify himself, said when asked about that: ‘I’m sorry. Libor?’
In New York, parishioners at Christ Church on Park Avenue are on a ‘fast learning curve’ about Libor and the economy, said Stephen Bauman, 56, the senior minister.
‘I think many people have never questioned certain fundamental aspects of our institutional existence,’ he said.
Hits on the Internet search engine Google show interest is increasing. In 2007, the US wasn’t in the top 10 countries where people searched for the term. Over the past seven days, the US has surged to No 2, behind the Czech Republic, where Libor is a common first name. Worldwide, the number of hits rose 10-fold from Sept 7 to Sept 30. Google won’t disclose the total.
White House spokesman Tony Fratto said at a press briefing this week that officials closely watch Libor, then paused.
‘Raise your hand if you’re familiar with the Libor rate,’ he said to two dozen reporters. Only one did, drawing nervous chuckles.
Libor is actually a set of rates, calculated for several currencies on periods ranging from overnight to 12 months. The British Bankers’ Association compiles the dollar rate every day from data submitted by 16 banks, including Deutsche Bank and Royal Bank of Scotland Group. There are also rates for the euro, Japanese yen, British pound, Swiss franc, and Australian and Canadian dollars.
Corporate bank loans are often linked to three-month Libor rates, which climbed to 4.33 per cent yesterday, the most since January. Libor also affects interest costs on credit cards, student loans and adjustable-rate mortgages. From 2004 to 2006, more than half of the US subprime mortgages at the root of the financial crisis, or those issued to the least creditworthy borrowers, had adjustable rates linked to Libor, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.
Americans’ lack of financial sophistication is a cause, not just a symptom, of the credit crunch, said James Bowers, managing director of the Center for Economic and Entrepreneurial Literacy, a nonprofit group in Washington. It may be a reason people are willing to take out loans for homes they can’t afford or add to credit card debt at adjustable rates.
‘When we go to a mechanic, we trust them to fix our problems,’ he said. ‘But right now, the mechanics on Wall Street can’t get their own cars to start.’
Bloomberg
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