Days after banks were warned not to fudge a benchmark lending rate, it has shot up.
Now trillions in loans could be affected, pushing up costs for borrowers across the board, perhaps even crimping a potential recovery.
It all started in Europe, where a flap arose around what’s called Libor, short for the London interbank offered rate. It’s the rate at which banks borrow amongst themselves.
The British Bankers’ Association decided to speed up its investigation into whether members were deliberately understating their borrowing costs. The theory was, any bank that reported a slightly higher rate could be seen as desperate, possibly in trouble.
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That happens "even if that bank is simply being more realistic than its peers in its estimate of actual term deposit rates on that day,” economist Lou Crandall of Wrightson ICAP told the Financial Times.
So they collectively reported the number low, in hopes to outdo each other, image-wise.
The decision to review Libor rates, however, seemed to have touched a nerve. It has been rising ever since.
The three-month Libor, the benchmark floating rate for U.S. corporate and mortgage debt, hit 2.82 percent on April 17, up from 2.74 percent the previous day. That was the largest increase since the three-month rate rose 0.12 percentage point on Aug. 9, 2007.
On the same day, Libor hit its highest point since March 13, when markets were focused on problems at now-defunct investment bank Bear Stearns.
The concern is that a sustained rise in Libor rates could mean higher debt payments for homeowners, companies and other businesses. Libor serves as the basis for interest rates of trillions of dollars in floating-rate corporate loans and mortgage loans.
They’re also used in hundreds of trillions of dollars in derivatives contracts like interest-rate swaps that companies and investors use to protect themselves against sudden changes in the relationship between short-term and long-term interest rates.
The increase may mean billions of dollars more in interest payments for companies and homeowners around the world, according to The Wall Street Journal.
In fact, the higher rates reflects what the banks most want to avoid right now — reality. The Financial Times called the rate rise a reflection of "deteriorating bank conditions.”
© NewsMax 2008. All rights reserved.
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