Some More Ways to Fix Libor

Two prescriptions to add to this one from Willem Buiter:

1) Have the Treasury guarantee interbank lending at maturities out to one year, charging a penalty rate consisting of a markup above clearance-level OIS rates plus a bank-specific insurance fee. Presumably the penalty rate would be significantly below current Libor levels but above the risk-free (i.e. Treasury) rate at the same maturity.

or

2) The Fed becomes the "counterparty of last resort" and lends unsecured in the interbank market:

Unsecured lending is an abomination to traditionally-minded central banks, even though the Fed has been cajoled buying commercial paper outright.  But buying debt instruments outright probably does not feel quite as nakedly unsecured as lending unsecured to banks. Too bad. The central banks will have to go where no central bank has willingly gone before, and lend usecured to private banks.  In mitigation, many of these 'private banks' are probably majority state-owned or at least minority state-owned by now.  All of the central bank's counterparities in the interbank market are de facto underwritten by the state.

The rate structure here would be similar to the first scenario and in both instances the government would pick eligible financial institutions that it would lend to.

But in order for either of these plans to work, central banks around the world would have to come to an agreement because of international scale of most big banks, says Buiter, who has been ahead of the game on where the Fed needs to move.

The latest word on why short-term Libor is still sky high is that banks are waiting for October 21st. That's when entities that bought protection against a Lehman Brothers default will get paid out from their CDS counterparties. And here is what the potential problem could be, according to Vipal Monga at The Deal (hat tip Felix):

...one market watcher speculated that big banks have been hoarding cash since the Lehman bankruptcy, specifically to make sure they have enough to meet CDS-related obligations.

So if we move past the week of 21st and nobody else blows up, then maybe Libor will come down by itself, but if not, the Fed will need to take one more step towards admitting that it's the only game in town for now.