Crescenzi On Libor: More Magic To Come

I have been anticipating for many weeks a break in Libor through its record low and it broke through at this morning's setting. Further declines likely lie ahead.

I note in my book, Stigum's Money Market, that the record low dates back to 1984 when the British Bankers Association began a trial period for its Libor settings; official BBA settings began on January 1, 1986. 3-month Libor fell for a 25th consecutive day, falling 2.063 basis points to 0.98625%, breaking the previous record low of 1.0% set on June 25th, 2003. (Libor is of course the London Inter-bank Offering Rate, the interest to which many debts are tied, including adjustable-rate mortgages, for example.) A confluence of factors is pressuring Libor lower, in particular the continued expansion of the Federal Reserve's balance sheet, which boosts the amount of money available for lending in the inter-bank system. Global rate cuts and shifts toward quantitative easing are also feeding Libor's drop.

Market participants were practically obsessed with Libor after Lehman's fall caused Libor to increase sharply. Libor's rise was seen as a sign that banks were "afraid to lend to each other." 3-month Libor went from a steady 2.82% before Lehman fell to 4.82% in early October, a clear sign that banks were leery of counter-party risks.

To address the Libor problem, the world's central banks and the Federal Reserve in particular began a major expansion of their balance sheets and created numerous programs to stabilize the money market. Two programs stand out: the Federal Reserve's Commercial Paper Funding Facility and its reciprocal currency-swap arrangements. The CPFF enabled issuers to tap the Fed for money, reducing the reliance upon bank credit lines. The swap facility enabled foreign central banks to obtain literally an unlimited amount of dollars in exchange for their own currencies. In both cases, the amount of money available for inter-bank loans increased, reducing its cost-Libor.

Additional programs such as the Fed's asset-purchase program have contributed to a further expansion of the Fed's balance sheet, further increasing the amount of dollars available in the inter-bank system, sustaining downward pressure on Libor. The Fed's purchases, which have thus far amounted to about $500 billion, leave the Fed with about $1.25 trillion of firepower, having committed to purchasing up to $1.75 trillion in securities ($1.25 trillion MBS, $200 billion agencies, and $300 billion of Treasuries). The purchases have the effect of boosting bank reserves, because the Fed purchases the securities with new money--with its printing press. These dollars can be lent in the inter-bank system.

The point in all of this is to recall the intense focus that existed months ago on a market critical to the proper functional of the global financial system. Many take for granted that the Libor problem has been resolved. It is a major positive and its decline has acted as an accelerant to recent trends in the financial markets.

Its decline by no means is enough to solve all that ills the financial system.


Tony Crescenzi
Tony Crescenzi

Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."