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I'm back online. My ISP - Time Warner - was down again. It's a weird feeling being out of touch.
I don't know what percentage of adjustable mortgages are tied to the Libor, but this is definitely bad news for housing (if the divergence in rates holds).
I can't believe how many emails I have waiting for me!
Best to all.
Financial Times
Crucial date in Bank of England's calendar - next 24 hours
FT.com / Capital Markets - Crucial date in Bank of England’s calendar
Can anyone comment what LIBOR is doing in other currencies?
The article made it sound like LIBOR is high in dollar denominated terms because banks are hoarding their US dollars. Could it also be that with the CDO's of sub-prime mezz tranches being spread far and wide in Europe and Asia, that these banks are simply less interested in US denominated debt? Could this also be the global market signalling fear of US inflation? Or are LIBOR rates entirely separate from those types of issues?
Thanks.
It is interesting that my thought this morning, which is completely on topic for once, is that the bear and the bull case seem more and more to revolve around how many dollars are going to get printed in the relatively near future.
I.e. the bears and the bulls are so enmeshed in the "financial industry" that they are removed from reality.
Which reality?
Well, the reality that says that only by printing a tsunami of dollars will the American consumer regain his footing. Her footing. And that tsunami ain't coming.
The LIBOR in particular indicates that, if anything, fewer dollars are going to get printed.
The American consumer has been lied to and raped, and now it's pregnant. Bad position to be in.
Perhaps a new conundrum?
The Wall Street Journal
Conduit Risks Are Hovering Over Citi
Debt 'Conduits' Are Hovering Over Citigroup - WSJ.com
Timely topic ! With LIBOR currently at 6.80 , any cut by the Fed to the fed Fund rate won't have the intended impact on ARM rates , which really is the eye wall of the mortgage hurricane. To a large degree , LIBOR rates have been impacted by the turmoil in CP , which really has been driven by buyer disdain due to asset quality and counterparty distrust issues. 25 bp by the Fed doesn't change the buy side opinion of ABCP.
For what it is worth, I have a couple of charts that might be worth a peek.
In the first, I took the home mortgage debt (in the flow of funds data) and charted it as a percentage of wages and salaries (using the IRS data). It's definitely rear view mirror stuff but you might not expect what you'll see.
Mortgate Debt vs Salaries and Wages
Another chart clearly shows parabolic growth that we once had in home mortgage debt.
Home Mortgage Debt Party
And lastly, for kicks and giggles I have supplied one theory on how we got here.
Just a theory of course.
My understanding is that part of the reason for this is banks are cutting back on lending and trying to build reserves because with the lockup in Lower Quality Commercial Paper many companies are expected to tap their lines of credit (ala Countrywide) when they can't rollover their Paper. Which would also be a pretty good explanation for why all the liquidity pumping by central banks is not getting money to the frozen markets, the banks who are borrrowing from the CBs are using the cash to increase their cushion instead of lending it.
It sure is mmazing how this "turmoil" keeps bouncing around from one thing to another. Subprime MBS->MBS->Commercial Paper->LIBOR and Treasuries
Amazon.com
The Big Picture blog recommends:
'A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation' - for those requesting financial book info.
Amazon.com: A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation (9780471227274): Richard Bookstaber: Books
Welcome back.
What would the rise in Libor do to ARM ?
Yal, the last ARM I had was indexed to the Libor, but I don't know what percentage of ARMs are indexed to the Libor these days. Maybe someone else knows, but this is bad news for those ARMs.
Best to all.
arbogast,
Well, the reality that says that only by printing a tsunami of dollars will the American consumer regain his footing. Her footing. And that tsunami ain't coming.
Part of me thinks the tsunami has been flowing in for decades and we just can't feel it yet, but as a rather middle of the road bear (neither shorting stocks nor hoarding hard assets) I tend to agree with you just the same.
However, I'm haunted by the chart of the cash equivalent money supply when adjusted for inflation (which is a fairly odd concept when you think about it).
Money, Money, Money
There's money out there I think, but what will it do?
If you really want to know the potential impact of LIBOR, the following speech by Bill Poole is required reading:
St. Louis Fed | Page Not Found
A trillion here and a trillion there, and pretty soon you're talking real money. (This may be a good time to bring the GSO financial statements up to date).
A good chunk of ARM mortgages have reset rates tied to LIBOR. For example, a few months back when this mess began I heard an ad for an ARM that was offering 5%. In the terms & conditions that are read at a rapid fire place they reveal that the reset rate was LIBOR+3, meaning the reset would be 8.69%.
I believe fixed mortgages had more of a direct relationship to the 10 year, but due to the risk environment the spread is increasing even there.
LIBOR is more tied into the rates set by the BoE, but Basel II capital requirements meant that the banks took on a lot of AAA papaer that turned out to be not AAA. Nobody wants to lend because they don't fully know their exposure to SIV or CDO.
Barclays had to go to the BoE discount window for $1.6 billion to bail out a hedge fund, this on top of the ECB being busier than a one legged man in an ass kicking contest.
The question now is if the Fed, BoE and ECB can bail faster than some of these banks can take on water. The bigger question is how hard should they try.
IMO, they've done a good job at price discovery for synth garbage so they can mark to market(even if it's a bit artificial) and they've done a good job providing liquidity when needed. They've got about two more weeks of doing this so people can shore up their house of cards, but after that they need to let fate run its course.
It's worse than the story tells. Many banks (including mine...) can't borrow at Libor, but are borrowing at Libor plus 20 to 40 bips out to the 3M. That hurts when you have x billion to roll. Eventually, the banks will have to decide between funding their IB operations or companies in the real economy. I'm afraid it will be easier to cut loose companies in the real economy.
Dear Calculated risk,
You are right ! better follow the spread (libor - fed funds). Before the Krach in 87 (n auguste and september) the spread was moving as today. If the spread does not move down we will have a Krach. Interestingly the spread is moving the same was in euro and UK£ and not in SF or Yen. fasten your seat belt !
Miju
More Bill Poole on GSO's and LIBOR:
FF=FreddieMac and Fannie Mae
"FF have not pursued the classic strategy but instead have financed a large fraction of their portfolios of long-term mortgages with short-term debt, in the order of 38 percent of the net mortgage portfolio or 34 percent of total assets. They hedge interest-rate risk by maintaining positions in interest-rate swaps. These contracts provide that, for example, Fannie Mae will pay a fixed rate of interest for the duration of the swap and receive a variable rate of interest, tied to the London Interbank offering rate, or LIBOR. Most swaps in the market use LIBOR as the reference rate in the swap contract, and so the GSEs use of these contracts is perfectly standard market practice.
It is true that the combination of short liabilities and interest rate swaps synthetically creates, almost, the equivalent of a long-term, fixed-rate liability. There are two significant caveats that explain the almost and neither of these are adequately discussed in the annual reports of Fannie Mae and Freddie Mac.
The first caveat concerns basis risk, which is briefly mentioned in Freddie Macs 2002 Annual Report (p. 76) but as far as I can tell not in Fannie Maes 2002 Annual Report or its 2003 10K report. Basis risk arises whenever a hedging strategy relies on a contract that is not identical to the good being hedged. In the case of the GSEs, the yield on the short-term debt they issue may differ from LIBOR. More importantly, the spread of the agency debt yield over LIBOR may change, and has changed significantly in the past. The interest-rate stress tests reported by Fannie Mae and Freddie Mac do not consider this possibility.
It is not difficult to make a back-of-the-envelope calculation of exposure to basis risk. At the end of 2003, Fannie Mae had approximately $335 billion of short-term debt swapped into fixed-rate long-term debt. Currently, 6-month agency paper trades about 10 basis points above U.S. Treasury 6-month obligations. However, that spread reached 50 to 70 basis points in the period from 1998 to 2001. Should the current spread rise from 10 basis points to 60 basis points for a sustained period, the extra 50 basis points would cost Fannie Mae about $1.7 billion in extra interest expense per year, which would reduce annual earnings by about 21 percent based on 2003 net income.
A 21 percent reduction in net income would not be enough to shake the firm; clearly, though, a larger increase in the spread would be a matter of serious concern. Such an increase could occur should the market come to distrust the creditworthiness of either Fannie Mae or Freddie Mac.
Full article:
St. Louis Fed | Page Not Found
FFDIC
The article about Citi is extremely interesting, but it just as extremely points out how this is all going to play.
Regulation of banks has been reduced to near zero over the past decades. Banks are now basically allowed to play the slots at Reno with depositors' money.
The Federal Reserve's mission is to protect the banking system.
Facts one and two above point in a single direction.
The banks will be bailed out...and with them every penny-ante crook in the "financial industry".
But it will require that money be printed. Money will be printed.
In honesty, I cannot see how we avoid $2.50 = 1.00
Banks' nerves jittery over subprime mess
Just posted that on my blog and wanted to make sure you saw it here. It even has a chart of the historical spreads.
A naive(?) question: does the BoE or the ECB have any control over the LIBOR? Does anyone?
And arbogast, I overall agree with you on all points. But, if US$ is inflated, won't all fiat currencies be inflated, including the euro? Myabe some currencies (e.g. resource-rich countries like Australia and Canada) will inflate less, but the US has been exporting money supply expansion for years. Won't it just get worse?
I have some numbers on LIBOR-indexed ARMs somewhere, but until I find it . . .
Subprime ARMs are just about universally indexed to LIBOR. The vast majority of them are 6-month resets, so the index is 6L. There's a small chunk with 12-month resets (12L).
Historically, prime ARMs were indexed to Treasuries (or COFI, cost of funds, a kind of hybrid of interbank borrowing and deposit rates within a Fed district). However, since 2001-2002 increasing numbers of up-in-credit loans are LIBOR-indexed. I believe more than half of Alt-A ARMs are LIBOR, most but certainly not all 12L. A smaller but significant chunk of prime GSE-quality ARMs are LIBOR.
These days, the biggest chunk of non-LIBOR ARMs are the Option ARMs. Some of those do use some maturity of LIBOR, but the MTA was very popular (Monthly or Moving Treasury Average, depending on whom you ask).
It is a safe generalization that the ARMs at biggest risk for other reasons (recently orginated, purchase money, high CLTV, lax underwriting standards), will be LIBOR-indexed. By the 2005-2006 period using a CMT index on a ARM was considered a quaint, old-fashioned habit, like spelling it "LIBOR" rather than "Libor."
The LIBOR may be more reliable than the fed growth at any price ignore inflation.
Must be warning the fed about a rate cut.
I think it is curious that so many people are telling the Fed to cut the Fed Funds rate to protect homeowners from foreclosure. With ARMs based on LIBOR, and LIBOR diverging from the Fed Funds rate, this is just further proof that the only ones who will benefit from a Fed Funds rate cut are the lenders.
Yes, spread between LIBOR and Fed rate is increasing, but look at divergence of one month LIBOR and one month Treasuries.
For many years both Treasury and LIBOR rates presaged Fed rate turns, but now they're diverging.
LIBOR = market cost of credit?
Treasuries = (relative) safety?
Best regards,
Bush urges China to spend, spend, spend
US President George W. Bush called Wednesday on Chinese consumers to spend more on American products to help reduce China's surging trade surplus with the United States.
Yahoo! 404 - Page Not Found
George pack sand.
Hahaha... because encouraging Americans to spend into oblivion has worked so well!
The problem with the printing money idea is that under no circumstances will wage inflation be allowed. Workers must be kept poor and one step away from the street. Any extra money printed will go to the gamblers and crooks, so there's no way to prop up housing prices (because nobody can afford them and the crooks don't want to play that game any more), so there's probably no real way to stop the housing market from declining (which is good in that least someday people may be able to afford a house.) Of course, we'll be looking at $5.00 a gallon gas and skyrocketing imports if money gets printed, but our wages won't change and housing will keep on sliding.
It seems common sense to me that the cost of borrowing should be greater when credit is tight. Will it affect ARMs? Of course it will.
I'm agog, as a liberal artsy do-little, how many numerate people there are out there; thanks for making this meltdown a little more comprehensible. A quick question regarding basic fairness. If Joe Jones and Joe Smith bought a house next door to one another, possessed identical credit and employment histories (and prospects), and had the same amount of money for a downpayment; but Mr. Jones did his due diligence and looked deep within his soul, and bought the $250/k house, and Mr. Smith didn't introspect, and took an exotic mortgage with a reset, and bought the house with the pool and the sub-zero and the granite countertops, and "paid" 500/k; is it possible that in a work-out Mr. Smith will end up paying the same monthly amount as Mr. Jones, while, in essence, getting to keep the twice-as-nice house, and only because he is a total f***-up? I don't know from LIBOR, but doesn't Mr. Jones have a serious beef here?
Moin,
this is from the end of August
1 Year ARM Surpasses 30 Fixed Year For The First Time
The average rate on a one-year adjustable mortgage surged to 6.51 percent, the highest since January 2001, from 5.84 percent the prior week. The rate also surpassed the cost of a 30-year fixed loan for the first time.
Between the SIV, the pier equity and LBO loans they guaranteed, you'd think that Citi is walking on a knife edge.
Normally I'd say they're too big to fail, but cripes on a cracker, if it all went boom they're too big to bail out.
"Right now because of the lack of a (social) safety net, many Chinese save for a rainy day," Bush said.
"What we want is for the government to provide more of the safety net so they can start buying more US and Australian products."
Way, way off topic, but this quote is just too funny.
AllanF,
It doesn't make sense for money market paper to register inflation worry directly. Longer maturity paper should register inflation worry directly. Money markets should reflect inflation worry indirectly, if central banks are expected to hike rates in response to inflation. That is not currently the case. The alternate explanation - that default risk premiums are rising fast - makes more sense. And yes, Libor rates quoted in euros and sterling are also headed up fast.
The issue of what happens to Libor if the Fed eases is the critical one, I think. Several posts have pointed out the divergence between Libor and Fed funds, but that divergence is what is at the heart of the present mess. Lack of confidence in banks is what has widened the TED spread and Libor. At any given spread between Libor and the relevant central bank rate, a lower central bank rate will mean a lower Libor. Only if an ease in some way reduced confidence would it risk increasing Libor rates.
By the way, Almunia of the ECB just told the European Parliament the ECB is ready to act to calm market volatility as early as tomorrow.
Yal, the last ARM I had was indexed to the Libor, but I don't know what percentage of ARMs are indexed to the Libor these days. Maybe someone else knows, but this is bad news for those ARMs.
Last time I checked the foreclosure listings at my local Registry of deeds and researched all the NOD's as well as actual Foreclosures everyone of them were Toxic ARMS tied to LIBOR//Everyone of them had insane cap points tied to LIBOR also. We are still in Virgin territory trust me, the pain is still in its first stages.
Worse part about the research is a lot of the people who refied to these toxic waste ARMS had their homes for a considerable amount of time..SUB PRIME is SCAPE GOAT.
Mooncalf,
I think you have that backwards.
If
Mr.Smith income = Mr.Jones income
Then
I would suspect that Mr.Smith will default and potentially lose his house as they both have similar spending expenditures (as you assumed) in other areas. Mr.Smith's monthly mortgage payment will rise substantially because he has an ARM so his interest on the principle is already more substantial (because it is X% on $500k initially and will grow to X+N+N1+N2% on $500k as time moves on and the interest rates increase/reset).
As an added kicker Mr. Smith's home will lose value as the housing prices "deflate" and he ends up paying more and more for an asset worth less and less.
I never got the memo that 'Libor' is the new LIBOR. I simply MUST catch up with the times.
That said, Tanta and others made the important point that virtually all subprime hybrid ARMs are indexed to 6-mo-LiBoR.
Moreover, the actions of the Fed do not immediately, nor necessarily, effect this rate. Neither does all the table-pounding Jim Cramer can muster.
Facts:
MOST ARMS are tied to LIBOR rate which is rising. Also, many credit card rates are also tied to LIBOR.
In 2008, there is estimated $355B of home loans set to reset to higher LIBOR rates.
Add in those in debt to credit cards who tried to save their homes by charging other bills to credit cards.
Fun times ahead.
arborgast,
I could not agree more. I was the first on this blog to write Citi would fail, however FDIC will bail it out. I only use a credit union.
Thank you k harris.
I don't trust reporting. The stuff I do understand they often get wrong. So I have no reason to believe on the stuff I don't understand, they'll get it right.
The Wall Street Journal 9/6/2007
Libor Pops Up
"The FDIC which joined the forbearance chorus this week, was notably late in promulgating stricter underwriting standards while the party lasted."
Libor Pops Up - WSJ.com
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