Wednesday, December 26, 2007

LIBOR: London's calling and your rates will be higher.



It's that time of year -- the news media is unleashing a horde of year end/year ahead stories on the public in an attempt to digest recent history and put it into a context that sheds some light on the road ahead. These stories can provide an opportunity to step back and look at the big picture, but they're also a newsroom staple because there's usually a dearth of news over the holdidays.
That's not the case this year, where the forces tearing apart credit markets aren't taking time off for the holidays. Bear Stearns Companies Inc. this week reported its first quarterly loss ever, thanks to $1.9 billion in writedowns on securities tied to subprime loans.
But stocks were up sharply today, in part because consumers weren't afraid to go Christmas shopping in November. While Americans were getting out their credit cards to buy gas and cheap imported goods, countries that have been making a good living exporting oil and manufactured goods to the U.S. have been busy buying stakes in Bear Stearns and other investment banks that are in dire need of capital because of their exposure to bad mortgage loans.
Back in October, Bear Stearns announced that an investment bank controlled by the Chinese government, Citic Securities, was buying a 6 percent stake in the company, with rights to increase its ownership to nearly 10 percent.
Another government-controlled investment fund, China Investment Corp. is putting up $5 billion fro a 10 percent stake in Morgan Stanley, which just reported $9.4 billion in writedowns on investments linked to bad mortgages. Citigroup said in November it would sell the Abu Dhabi Investment Authority a 4.9 percent stake in the company for $7.5 billion.
The Wall Street Journal reports Merrill Lynch is looking to sell a $5 billion stake in the company to Singapore's state-run investment fund, Temasek Holdings Ltd. Singapore has already taken a $10 billion stake in Swiss bank UBS through Singapore Investment Corporation.
All this foreign investment in Western banks is not necessarily a bad thing, by the way, at least if you believe the Financial Times, whose editors say it wouldn't be happening if these banks didn't look like profitable investments. They may also be looking after their own interests and trying to assist the Fed and European Central Bank in preventing a total collapse of credit markets.

Credit markets could be the canary in the coal mine indicator of a U.S. recession in 2008, according to one of the more insightful year-end/year-ahead stories out so far, "Seven economic warning signs" by MarketWatch's Rex Nutting.
"The biggest unknown in the economy right now is the condition of short-term credit markets that big businesses rely on for their immediate funding needs. Some of those markets are functioning well, but others are clogged up," Nutting writes. "Some firms, especially those in the mortgage business, can't sell commercial paper at any price. Other companies can't get funding from banks because banks are hoarding their reserves."


Nutting says to watch what happens to the spread between the London Interbank Overnight Rate(LIBOR) and the 3-month Treasury bill, which used to be comfortable right around 10 basis points but has been more like 75 lately (indicating just how tight credit has become).
"The Federal Reserve and other central banks have been trying to Roto-Rooter the system, flushing it with cash too cheap to pass up," Nutting says. "The Libor rate should show how successful they are."



This is an extremely important matter as almost 90% of the adjustable mortgages are based on either the 6-month or 1Y LIBOR. The majority of adjustables were done when the LIBOR rates were in the 1-2% range. LIBOR as of today is trading around 4.45%. So client's looking at adjustables are finding that it makes more sense to go with a fixed jumbo loan. The fixed mortgage products are more closely tied to the movement of the 10Y US Treasury rate which is hovering around 4.28% today. In general, I advise clients to carefully consider the numerous benefits of using a fixed rate loan structure for their jumbo loans. The new year brings a lot of hope and opportunity for the credit markets to sort out the mess. I expect "money good" clients to have easy access to the jumbo loan structures they need and would expect LIBOR to settle down given the orchestrated action of the major central banks to ease the credit pressures. Have a wonderful holiday shortened week.

1 comment:

alex said...

Hi. One small comment -- The Libor/Treasury Spread, also called the TED spread, is historically higher than 10 bps. The spread that has been closer to 10 bps over the last few years and is now about 75 bps is the 3 month Libor over the Fed Funds Rate.

In either case, Libor spreads remain significantly elevated due to the suspicions banks have about each other's balance sheets (because of information asymmetries -- which have shown to be a classic cause of market failure)