Libor’s Creep Shows Credit Markets at Risk of Seizure

March 11 (Bloomberg) — The cost of borrowing in dollars is rising as the global recession deepens and central bank efforts to prop up the financial system fail to prevent a growing number of banks from requiring government bailouts.

The London interbank offered rate, or Libor, that banks say they charge each other for three-month loans stayed at 1.33 percent today, near the highest level since Jan. 8 and up from this year’s low of 1.08 percent on Jan. 14, the British Bankers’ Association said. The Libor-OIS spread, a gauge of bank reluctance to lend, widened to the most since Jan. 9.

Short-term borrowing costs are increasing as banks hoard cash and governments struggle to thaw credit markets after finance companies reported almost $1.2 trillion of writedowns and losses since the start of 2007. Banco Popolare SC yesterday became Italy’s first lender to seek state aid. Lloyds Banking Group Plc, the U.K.’s largest mortgage provider, ceded control to the government March 7. U.S. regulators seized 17 failing banks so far this year.

“The market is beginning to think that the solution is either not politically possible, or we can’t afford it, or maybe there isn’t a solution,” said Bob Baur, chief global economist at Des Moines, Iowa-based Principal Global Investors, which manages $198 billion of assets. Libor’s rise “is just another indication of that concern,” he said.

The U.S. committed about $10 trillion to combat the financial crisis that started in August 2007 as losses on securities tied to subprime mortgages caused credit markets to seize up. European governments put up more than 1.2 trillion euros ($1.5 trillion) to protect their banking systems.

No Trust

Rising Libor shows banks remain skittish 19 months later because they still don’t know if they can trust each other, said Soren Elbech, treasurer of the Inter-American Development Bank, a Washington-based lender to Latin American and Caribbean countries. Libor is used to calculate rates on $360 trillion of financial products worldwide, according to the Bank for International Settlements in Basel, Switzerland.

“Counterparty risk appetite is something that’s very much” on investors’ minds, Elbech said in a phone interview yesterday.

The stress is reflected in the so-called Libor-OIS spread, which measures the gap between three-month Libor in dollars and the overnight index-swap rate, or what traders expect the Federal Reserve’s target rate for overnight loans between banks to average during the term of the contract.

That spread averaged 11 basis points from December 2001 to July 2007, and soared to 364 basis points in the weeks following the Sept. 15 bankruptcy of Lehman Brothers Holdings Inc. Libor- OIS was 107 basis points yesterday. A basis point is 0.01 percentage point.

Forward Contracts

Contracts in the forward market show traders expect the spread to narrow to 85 basis points in a year, according to data compiled by Tullett Prebon Plc, the second-biggest broker of transactions between banks after ICAP Plc.

While the gap is forecast to shrink, Alan Greenspan, chairman of the Federal Reserve from August 1987 to January 2006, said in June he won’t consider markets back to “normal” until Libor-OIS falls to 25 basis points.

Dollar Libor for three months rose for 11 days through yesterday as banks sought cash to cover commitments through the end of the first quarter.

“The liquidity will be horrible in the next couple of weeks,” Vincent Chaigneau, head of international rates strategy at Societe Generale SA in London, said yesterday.

Credit Market Cracks

While stocks around the world staged their biggest one-day rally of the year yesterday after Citigroup Inc. said it was having its best quarter since 2007, credit markets weakened.

The extra yield investors demand to own U.S. corporate bonds instead of Treasuries rose to 8.09 percentage points, the most since December and up from the low this year of 7.03 percentage points on Feb. 11, according to Merrill Lynch & Co. index data.

Wider borrowing spreads show growing concern about corporate defaults as the recession worsens. The global economy will contract this year in what can be called the “great recession,” Dominique Strauss-Kahn, managing director of the International Monetary Fund, said in a speech to African central bank governors and finance ministers in Dar es Salaam, Tanzania, yesterday.

“The IMF expects global growth to slow below zero this year, the worst performance in most of our lifetimes,” Strauss- Kahn said. “Continuing deleveraging by world financial institutions, combined with the collapse in consumer and business confidence, is depressing domestic demand across the world.”

Nationalize Banks

Strauss-Kahn later told France 24 Television it may make sense to nationalize some U.S. banks.

“The debate over nationalization certainly exists in the U.S.,” Strauss-Kahn said. For some banks “this would be a good solution,” he said, without naming specific financial companies.

The Federal Deposit Insurance Corp. classified 252 banks as a “problem” in the fourth quarter, up 47 percent from the third quarter.

Fed Chairman Ben S. Bernanke said yesterday in Washington that if officials can make financial markets “reasonably stable” then “there’s a good chance that the recession will end later this year, and that 2010 will be a period of growth.”

The Fed chief, answering questions after a speech, prefaced his comment by saying his “forecasting record on this recession is about the same as the win-loss record of the Washington Nationals,” the worst team in U.S. Major League Baseball last year with 59 wins and 102 losses.

Bernanke said that a 10 percent U.S. unemployment rate is “well within the realm of possibility” and is part of the “adverse” second scenario for so-called stress tests that regulators are performing on the 19 largest American banks to determine how much more capital the government will provide.

To contact the reporters on this story: Gabrielle Coppola in New York at gcoppola@bloomberg.netLiz Capo McCormick in New York at emccormick7@bloomberg.net

Last Updated: March 11, 2009 08:33 EDT
By Gabrielle Coppola and Liz Capo McCormick

Source: Bloomberg

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