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This Is Getting Heavy - Bank Rates Soaring

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The cost to banks of borrowing money over a three-month period hit a near-ten-year high yesterday as Britain’s biggest financial institutions searched for medium-term funding to help them to ride out the turbulence in the credit markets.

The London interbank offered rate (Libor) for three-month sterling reached 6.74 per cent, beating last Friday’s record. It is the highest since the Long Term Capital Management hedge fund crash sent shivers through markets in December 1998.

Barclays disclosed that it was paying the highest rate of all banks for three-month money, estimating that it would cost the bank 6.8 per cent – more than the Bank of England’s 6.75 per cent penalty rate – to borrow sterling. That failed to dampen the bank’s share price, which leapt almost 4 per cent to close at 638p yesterday after Bob Diamond, the chief executive of Barclays Capital, reassured the market that the bank had not made significant losses in the recent market turmoil.

Meanwhile, Kensington, bought in May by Investec for £273 million, is the latest mortgage lender to react to rocketing Libor and a growing distaste among investors for risky mortgage-backed securities. The sub-prime specialist told brokers that its variable rate would rise from 7 to 7.8 per cent on Friday. It said that it planned to reprice and tighten the lending criteria on mortgages for people with a bad credit history.

Libor for three-month euro borrowing jumped to 4.74 per cent, the highest since May 2001, and US dollar Libor rose to 5.66 per cent, a 6½year record. Worries about losses from US sub-prime mortgage investments has made banks reluctant to lend to each other for lengthy periods, forcing up the cost of borrowing.

Sources said the availablity of three-month money had almost entirely dried up. “There’s plenty of liquidity at the shorter end, but at the medium term it is very, very illiquid,” one bank source said.

According to figures from the British Bankers Association, Barclays is paying the most of 16 top banks for three-month sterling and dollars and the second-highest rate for euros. But the bank, which has twice been forced to obtain emergency credit from the Bank of England in recent weeks, is able to access cheaper overnight sterling than its high street counterparts Abbey, HBOS and Lloyds TSB.

Sources at the bank said that because the lack of liquidity meant that little actual borrowing was occurring. banks were providing the BBA with estimates of what rates they thought they could borrow at. Barclays is merely being more conservative than other banks in its estimates, the source said.

http://business.timesonline.co.uk/tol/busi...icle2381584.ece

OUCH!!

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This will seriously affect profits of financial institutions, results of which should be disclosed in September.

IMO This will be the catalyst which crashes the markets as the uncertainty on Sub Prime Lending, CDO's and MBS's will be laid out for all to see and scrutinise, whereas at the moment no-one has a handle on its real affect yet.

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So, how is that? Is it really just perceived risk that makes LIBOR so expensive, or is it more the markets telling the BoE that even the riskless rates should be higher?

Barclays are trying to manipulate LIBOR so the BoE has to defend the 5.75% rate, just like the Fed defends the federal funds rate. However, defending the base rate isn't the BoE's job...

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So, how is that? Is it really just perceived risk that makes LIBOR so expensive, or is it more the markets telling the BoE that even the riskless rates should be higher?

Simple supply and demand Goldfinger.

No-one trusts anyone anymore so are only prepared to lend short term (The fear stage), short term lending has hit the roof and thus so has the LIBOR.

Libor for three-month euro borrowing jumped to 4.74 per cent, the highest since May 2001, and US dollar Libor rose to 5.66 per cent, a 6½year record. Worries about losses from US sub-prime mortgage investments has made banks reluctant to lend to each other for lengthy periods, forcing up the cost of borrowing.

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Barclays are trying to manipulate LIBOR so the BoE has to defend the 5.75% rate, just like the Fed defends the federal funds rate. However, defending the base rate isn't the BoE's job...

Hmmm

can you please explain how a high LIBOR rate would affect the BOE and their decision to keep the base rate at 5.75?

At these LIBOR rates banks would be better off borrowing from their central banks short term at their discount rate. Maybe this is why Barclays has been recently.

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Barclays are trying to manipulate LIBOR so the BoE has to defend the 5.75% rate, just like the Fed defends the federal funds rate. However, defending the base rate isn't the BoE's job...

What do you mean by Barclays trying to manipulate it? You mean they want a base rate cut?

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What do you mean by Barclays trying to manipulate it? You mean they want a base rate cut?

Not cut the base rate but put them under pressure to reduce the penalty when borrowing from the bank of england.

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Not cut the base rate but put them under pressure to reduce the penalty when borrowing from the bank of england.

OK, a disount rate cut as done by the Fed. Got it. Yes, they could do it, and everyone and their dog would take out loans from the BoE, I suppose.

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OK, a disount rate cut as done by the Fed. Got it. Yes, they could do it, and everyone and their dog would take out loans from the BoE, I suppose.

Hmmm

Boe extended their short term discount rate to 1 month IIRC (or is that the fed), anyway the discount rate is far too short term so not a very good credit vehicle.

However Avid Fan explicitly quoted 5.75% and the Base Rate and The Fed Funds Rate NOT the Discount Rate.

Can you please elaborate Avid Fan, what do you mean trying to make BOE defend the Base Rate?

Also .. I don't think Barclays is a bad a$$ enough bank to manipulate LIBOR on its own.

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OK, a disount rate cut as done by the Fed. Got it. Yes, they could do it, and everyone and their dog would take out loans from the BoE, I suppose.

All the bankers are crying out help reduce reduce, lets see if the boe bend over, the money is drying up really fast no more money at cheap rates, banks dont make any more and even lose money if they have to pay 1% above base rate. They dont like that i think the BOE should say well your trying to push us into a corner we'll just up it by .25 ;).

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Hmmm

Boe extended their short term discount rate to 1 month IIRC (or is that the fed), anyway the discount rate is far too short term so not a very good credit vehicle.

However Avid Fan explicitly quoted 5.75% and the Base Rate and The Fed Funds Rate NOT the Discount Rate.

Can you please elaborate Avid Fan, what do you mean trying to make BOE defend the Base Rate?

Also .. I don't think Barclays is a bad a$$ enough bank to manipulate LIBOR on its own.

I'm probably not the oracle you take me for. However, as I understand it, the LIBOR rate up to 3 months should basically be the base rate. There's absolutely no problem with it rising above this rate for overnight, 1 month borrowing and so on. The BoE doesn't defend the base rate or LIBOR as such, but as mentioned, it can change the penalty rate for lending. This will have the effect of removing the pressure from interbank loans and LIBOR will drop (they can get the money from the BoE). By putting in a high bid, Barclays have an effect on LIBOR, pulling it higher (its the average of a number of bids from a number of banks).

The FED actually does directly compete to maintain their "funds rate" that we all know as currently being 5.25%. The Fed makes the pool of reserves from all banks part of the Federal Reserve System available for lending out, if required. If banks decide to participate at a higher interest rate, the Fed steps in and makes money available itself so banks can borrow at the 5.25% rate without problems. This prevents a "credit crunch" (in theory at least). The discount window (the Fed discount rate) is something else (direct borrowing from the Fed) and not everyone has access to it. The discount window is analogous to the penalty borrowing rate offered by the BoE. Because this is the only tool the BoE have available, they may be convinced to lower the penalty rate to maintain LIBOR at the base rate.

Edited by AvidFan

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Another important point to remember is that the discount window offered by the Fed has been used recently to inject liquidity into the investment banking arms of America's top banks. It hasn't been used to add liquidity to their commercial banking operations, which are part of the Federal Reserve System and should have access to unlimited funds at 5.25%.

In the UK, I'm actually not sure if the BoE will lend to both investment and commercial banking sectors. Perhaps with the penalty rate being so high, it doesn't mind who it lends to.

The waters have been muddied further recently because the Fed allowed Citigroup and BoA to increase the funding of their investment banking arms from depositor's money from their commercial banking arms. It was 10% (limited by the Banking Act, 1933) but has temporarily been increased to 30% - probably around $25 billion per bank.

This means that in theory, if the investment banking arms of these banks go pop, it would exacerbate any demand on reserve withdrawals from their commercial banking arm and may precipitate a full-on bank run and subsequent total crash (Cue Cgnao...)

Edited by AvidFan

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In normal circumstances there is enough short-term paper that banks can trade at a rate which is in line with expectations of the base rate. When there is a scarcity of short-term paper :o it trades at rates which are more expensive...

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I'd have to say that if Citigroup or BoA went pop, as just these two control over $130 trillion in derivatives (around 3.5 times the world's total GDP), it would be "the end" of the financial system as we know it.

If banks in the UK start using large chunks of depositors money to prop up their investment banking arms, it would be time to pull your money out and hide it under the matress.

One reason I can forsee banks may want to "get in early" with their borrowing is so that it is not seen as reactionary to worsening economic conditons. If we come to accept emergency lending as a regular-ish event, its less lilkely to cause panic. British bankers could always try what the Germans have done recently of course and just keep their mouths shut.

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in lay man's terms:

it's costing banks more to borrow money right?

won't these banks pressure Mervyn and his gang to raise interest rates? if IR rates increase then folks would have an incentive to save which would give the banks more money- i guess the amount people would save wouldnt be enough to help the banks, they need serious money- ie billions to avert a credit crunch.

let me know if i'm wrong :)

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One reason I can forsee banks may want to "get in early" with their borrowing is so that it is not seen as reactionary to worsening economic conditons. If we come to accept emergency lending as a regular-ish event, its less lilkely to cause panic. British bankers could always try what the Germans have done recently of course and just keep their mouths shut.

That's the problem british banks have always kept thier mouths shut which has always caused problems, either barclays are trying to hedge their bets or are in a mess. we'll find out towards the end of the week.

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in lay man's terms:

it's costing banks more to borrow money right?

won't these banks pressure Mervyn and his gang to raise interest rates? if IR rates increase then folks would have an incentive to save which would give the banks more money- i guess the amount people would save wouldnt be enough to help the banks, they need serious money- ie billions to avert a credit crunch.

let me know if i'm wrong :)

The BoE won't raise IRs under these circumstances. But just as we're seeing SVR mortgages rise to circa 8%, we'll see attractive savings rates offered so banks can get more money in. Even if they offer savers 7% 1 year bonds, there's still a good 1% differential with the debt they sell.

What we're seeing is a detaching of BoE monetary policy from the policy the commercial banks need to adopt to survive and self-regulate. Why have the BoE (or even the government) hike the base rate up and down by 100 basis points from one month to the next trying to control the economy? Let the commercial banks control their own destiny - they can choose to fry themselves if they so wish.

I find this concept similar to the one that states we have too many road signs these days. Because we can always look up to find out what speed we should be travelling or what lane we should be in, we can afford to be distracted the rest of the time and this causes an increase in the number of accidents. Take all the signs away and drivers are so wary, the accident count falls.

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in lay man's terms:

it's costing banks more to borrow money right?

won't these banks pressure Mervyn and his gang to raise interest rates? if IR rates increase then folks would have an incentive to save which would give the banks more money- i guess the amount people would save wouldnt be enough to help the banks, they need serious money- ie billions to avert a credit crunch.

let me know if i'm wrong :)

Nooooo, we don't have enough money in their vaults, even at higher rates to promote savings it would have such a detramental affect on the economy with lay offs etc. You can't save if you,re not earning.

The way to pump money is to drop rates, unfortunately there is not enough room in the system to do this (again) as inflation even hyperinflation would be the result.

So basically raise rates get a recession/depression

Drop rates risk inflation (the most evil of all monsters)

Do nothing and see what happens.. safest bet.

Unfortunately with inflation still a problem raise rates is what should be happening but the pain that would cause is too much to bear, CB's will sit on their hands and try and manipulate just like the US has been doing for the past 14 months or so. This cannot last much longer as the markets are stronger than any government, it's gonna be an interesting ride these next 12 months, buckle up and try to find as much impartial reports you can to find the next bubble - IMO we are looking at precious metals and energy.

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