The London interbank offered rate is now viewed as a useless indicator by many in the credit markets. It continues to have a legacy effect on the markets, however, because of the huge amount of existing credit products, some $360 trillion, that are benchmarked against it.
We first pointed out that LIBOR was broken way back in January. “What’s happened is that government rescues broke the credit markets, making them an unreliable indicator of financial health and economic strength,” we wrote.
The problem has lately been getting a lot more attention. A month ago, Breaking Views reported that bank profits had become dangerously reliant on government guarantees that in turn lead to lower borrowing costs. Bloomberg commented that the artificially low Libor was masking “a growing gap between the rates that the biggest banks charge each other for credit.” That gap is especially pronounced between the large systemically important banks and smaller competitors.
The biggest institutions are able to fund themselves at around Libor levels while smaller institutions have to pay, in some cases, more than 100 basis points above Libor. This is explained by continuing counterparty risk in what remains an uncertain economic environment.
Most recently, James Bianco writes (via Tyler Durden of ZeroHedge): “Curiously, the LIBOR debate is moving to a more econometrically-focused audience and has led none other than the San Francisco Federal Reserve to come out and indicate that LIBOR is essentially flawed as a metric, as it now reflects not so much the risk in the system, but the guarantees by the US government itself.”
Here’s that Fed paper: