The Libor vs. Treasury Rate
Friday, September 14, 2007PAUL KANGAS: Economic worries are spreading from Wall Street to Main Street these days with one big concern, the unusually large spread between what's called the libor and the Treasury rate. The London inter-bank offered rate usually trades in tandem with the Treasury rate, but over the last six weeks, it has jumped nearly a half percentage point higher. As Stephanie Dhue reports, the libor is the benchmark interest rate for many adjustable rate mortgages and business loans.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: The interest rates paid on adjustable rate mortgages reset based on an index. For 80 percent of sub-prime loans, that index is the libor. Global Insight economist Brian Bethune says this means some borrowers will be facing even higher payments.
BRIAN BETHUNE, US ECONOMIST, GLOBAL INSIGHT: Any borrower that has the libor in the fine print on their adjustable rate mortgage right now faces a pretty significant bump in terms of the adjustable rates, not only from the fact that the Federal funds rates are up over the past year, but also the spread on libor has increased.
DHUE: The reason for the unusually wide spread between Treasuries and the libor is that investors fear more bad loans could be lurking in mortgage-backed securities market. Mortgage Bankers Association economist Jay Brinkmann says banks moved to the libor index to boost returns.
JAY BRINKMANN, VP OF RESEARCH & ECONOMICS, MORTGAGE BANKERS ASSN.: Whenever we have a flight to quality, if there is an event in the economy, such as over the last month, 2001, with the Russian debt crisis back in 1998, that there is a flight to Treasury instruments and that artificially drives down yields on Treasuries relative to the rest of the economy and the rest of the rates that institutions are paying.
DHUE: The libor is also the benchmark for short-term corporate loans. Known as commercial paper, the market has grown from $40 billion in the 1990s to a $2 trillion market today.
BETHUNE: Corporations borrow floating rate based on spreads over the libor, so if libor rates go up, that impacts a very wide range of borrowers in the marketplace, including corporations.
DHUE: Former Fed Governor Lyle Gramley expects the libor rate to come down relative to U.S. interest rates. He says that could be spurred if the Federal Reserve reduces the Fed funds rate.
LYLE GRAMLEY, FORMER FEDERAL RESERVE GOVERNOR: I think also that the Fed is going to ease monetary policy and bring short term interest rates down generally. I wouldn't be at all surprised to see the funds rate 75 basis points lower at the end of this year than it is at the present, down to 4.5 percent and maybe even lower.
DHUE: The spread between the libor and Treasuries has narrowed somewhat in recent days. But with lingering uncertainty over bad mortgage debt, observers aren't sure that trend will continue. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
