This week, Libor rose to more than 0.5%, having more than doubled in the past few weeks. 0.5% may not sound like much, but it means that the actual cost of funding a loan has doubled.
So what is going on? Libor is set by a small group of dedicated people in Canary Wharf who collect a range of quotes from banks; they discount the top and bottom quarter, then take the average of the rest. So Libor is a robust data point – any increase is broad based and is a sign of widespread stress or distrust across the banking system.
Another important signal - the US Dollar-Euro swap has been revived; in the words of the Fed:
"In response to the reemergence of strains in US dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the re-establishment of temporary US dollar liquidity swap facilities...The Bank of Japan will be considering similar measures soon.”
Another pointer: the US Adjustable Rate Mortgage rollover is approaching a major bulge this summer. The Federal mortgage agencies are now responsible for 90% of new US housing market lending, so if they choose to renew the wave of maturing home loans then they will have to add to the Federal deficit - taking further loans off the banks. Good news for some of the US banks!
New SEC regulations require money market funds to avoid all but the shortest dated commercial paper. This has had an unexpected side effect - the mighty BBVA found themselves financially embarrassed by the failure of their latest CP offering. And the Spanish banking industry is showing further strain – this week the Government seized one Caja bank and merged four more.
So one reason for Libor rising is fewer buyers for Commercial Paper - causing a temporary squeeze in corporate funding around the world. Headaches for corporate Treasurers who need to roll over the CP programs every month; and strain on their bank funding lines; and enough to push some marginal companies over the edge. It is worth looking closely at how some of your equity investments are funding themselves...
