MORTGAGE
LIBOR, other interest rate indexes
The LIBOR is among the most common of benchmark interest rate indexes used to make adjustments to adjustable rate mortgages. This page also lists some other less-common indexes.
Click on the links below to find a fuller explanation of the term.
Ratings methodology
Who are they for? These indexes are of interest to investors and borrowers alike, especially those who have mortgages or business loans tied to these indexes.What's included? The Bond Buyer 20 bond index is a barometer for yields on tax-free bonds issued by state governments and local municipalities. The Fannie Mae 30-year mortgage commitment for delivery within 60 days helps mortgage lenders determine what rates to charge on 30-year fixed rate mortgages that are to be sold to Fannie Mae within the next 60 days. The LIBOR rates, which stand for London Interbank Offered Rate, are benchmark interest rates for many adjustable rate mortgages, business loans, and financial instruments traded on global financial markets.
And From Pragmatic Capitalist
IS LIBOR FORECASTING THE NEXT LEHMAN?
4 MAY 2010 BY TPC 3 COMMENTS
We read this article from Bloomberg with interest. Recently, 12 month LIBOR rose above 1% for the first time since late 2009. In short, we are told that LIBOR has been on the rise because the economy is strong and everyone is expecting a rate hike from the Fed. We will tell you at the outset that we don’t agree 100% with this analysis. To understand why, let’s start by defining LIBOR. The London InterBank Offered Rate (LIBOR) is a reference rate that is calculated by asking a group of contributor banks
the following question:
“At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”
For the US Dollar rate, there are currently 16 banks that make up the panel. Each bank answers the question above every day, and LIBOR is calculated by using the trimmed average of the rates from these 16 banks by ranking them from highest to lowest and dropping the top and bottom quartiles (hence the “trimmed” average). The rates in the middle quartiles are averaged to get LIBOR for that day. Another plain language definition: this is the rate at which banks will lend to each other on an unsecured basis. The fact that this is an unsecured rate means that the rate contains information about credit/counterparty risk in the banking system. During the worst of the credit crunch, in the days following the bankruptcy of Lehman Brothers in September of 2008, LIBOR increased dramatically. At its peak, it traded at a spread of 3.64% to the overnight index swap rate (the LOIS screen for all of you Bloomberg users).
This didn’t happen because traders were pricing in a Fed rate hike; it happened because banks stopped trusting each other. And as you can see in the chart below, they stopped lending to each other as well.
It’s no coincidence that this LIBOR spike and drop in interbank lending were followed by the dramatic rise in excess reserves held at the Federal Reserve and rise in discount window borrowing and the use of special bank liquidity facilities at the Fed. The Fed began paying interest on excess reserves in early October of 2008, and we’ve seen a gradual departure of the US banks from the interbank lending market ever since. Instead of lending to each other unsecured, they put their money to the Fed and the Fed lent it out, standing in as the middle man. Why would anyone lend unsecured at 0.26% when you can lend to the fed risk free at 0.25%? The answer from the chart above should be obvious: you wouldn’t.
Our read on the recent rise in LIBOR is that it has more to do with credit worries (on exposure to Greek and other troubled sovereign debt) than rate hike expectations. LIBOR really got moving to the upside in mid-late April, which coincided with the spike in Greek sovereign CDS from around 600 to over 1,200. During that same period of time, 12 month LIBOR has risen from about 0.87% to above 1%, as touted in the Bloomberg article above. If this move was related to expectations of rate hikes, this would show up in the Fed funds futures contracts as well. Over the last month, the implied probability of a Fed hike to 0.5% in September of 2010 has fallen from 38.6% to 26.4% and probability of a move to 0.75% has fallen from 6.2% to 1.9%. The probability of no change in rates at the September meeting has risen from 54.1% to 67.5%. To summarize, the perceived chance of a rate hike has been declining as of late, not rising. Given this reaction from the Fed funds futures pit, it’s hard to blame the rise in LIBOR on strong economic growth and the expectation of future rate hikes by the Fed. It’s much more likely that LIBOR is reacting to counterparty risk rearing its ugly head once again. It may still be early, but perhaps Greece is the Lehman of 2010.
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