Wednesday, April 16, 2008

Libor Rate Being Underestimated

The Libor, London Interbank Offered Rate, was created in the 80s and is a fundamental piece of the global financial system. It is computed in London every morning from data supplied by the world's banks and indicates the average interest rate that banks use to lend to each other.

The Libor rises when banks are in difficulty and drops when all is good. Interest rates on trlllions of dollars in debt are set by the Libor. In the last few months of troubles, the rate has shot up. The differecne between the 3-m ointh TBill and the Libor, a measure widely see as indicative of the financial health of banks, has gone from 0.4% in August 2007 to 1.6% today.

There are growing suspicions that the banks troubles are worse than they admit and that they do not wish to inform the real high rates they are paying because that would show how desperate for cash they are. If the banks are lieing, this also means that borrowers are paying less than what they should for their loans.

The BBA, British Bankers Association is reportedly investigating the misreporting issues. Concerns are in the written minutes of the Banbk of England meeting back in November 2007.

An analyst of Citigroup ( Scott Peng) estimates that the Libor is being underestimated by as much as 0.3%. If this is correct, the implications are tremendous.

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