LIBOR May Be Unreliable as a Market Weathervane

Includes: AGG, DIA, IWM, QQQ, SPY
by: Mark McQueen

If you’re not lending to your neighbour, why does it matter what you’d charge him if you did?

On last week’s BNN Television Streetwise panel with the Globe and Mail’s Boyd Erman, we mused that placid London Interbank Offered Rate (LIBOR) was an indication that all was well in the bank market. We agreed that it was something to keep an eye on, but that up until that point at least, the lack of volatility must mean something. That a massive five alarm crisis was not yet upon us. The figures below are from Bankrate, and show LIBOR as of August 10th, last week, and 12 months ago:

1 month LIBOR: 0.21, 0.19, 0.29
3 month LIBOR: 0.28, 0.25, 0.40
12 month LIBOR: 0.76, 0.74, 1.00

The lesson was drawn from 2008, when steady increases in LIBOR rates implied that banks were no longer trusting each other. But, later, there emerged a few voices who claimed that the key banks that set the interbank offered rate in London were actually conspiring (not my word) to keep the rate down, knowing that a lower rate told the world that large global banks were healthy, sound, and confident in the financial system. After all, when confidence ebbs, banks are among the first to feel it.

It is hard to imagine that global confidence in the international financial system is higher than it was a year ago. But that’s exactly what LIBOR rates are telling us, with 12 month LIBOR coming in at 0.76, versus 1.00 a year ago. Seems rather crazy, with French bank shares dropping like a stone over balance sheet concerns. And as I mentioned last week to BNN’s Kim Parlee, BBVA and Santander own equity boxes are more than swamped by their ownership of Italian government bonds.

Three years after the crisis, I’m thinking LIBOR is no longer going to help us predict a seizing-up of the bank market. If you are the top risk manager at a healthy bank in Asia or North America, the issue will be to simply cut your lines (exposure) completely; why increase the price you require from an overseas bank that you’re less than sure about? If you’re worried, just cut the lines. Lines that were invariably reduced post 2008 in any event.

There are times in life when you can’t price appropriately for risk. Why else would LIBOR be down 24% year over year?