libor et labor

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Why LABOR over LIBOR?

Part of what I do is educate clients and readers.  The topics range from topical news stories to mortgage planning strategies, to warnings of potential scams and frauds.  This last month had the liquidity crisis on the front pages.  

So naturally, I spent a good deal explaining how lenders sell their pools of loans, how those loans are securitized.  I also explained what happened to Jumbo loans, Alt-A loans, and the like.

This month may be the month of the LIBOR.  It's just starting to hit the mainstream news.  So here's your official

 "What the heck is a LIBOR and why should I care?"

explanation.

LIBOR is an index.  LIBOR stands for London Interbank Offered Rate. It's the interest rate on dollar denominated loans that one London bank might make to another.  London?  As in London,  England?  Yeah.  Weird, eh?

LIBOR is considered a "cost of funds" styled index.  Actually, it's sometimes called one of the best because it tracks the borrowing cost for some of the most credit worthy, well established banks.   Did you know that 20% of all international bank lending goes through the London banking system?

LIBOR is about short term rates.  It deals in loans from overnight to one year out.  The rates are determined by the British Bankers Association (BBA) each day over tea.  Ok, I made the tea part up.  Call it embellishment.

So Mike, what does this have to with mortgages?

LIBOR is widely used as an index for setting the rates on ARM loans, especially of A and Alt-A quality borrowers. 

Remember the math on computing ARM rates?  Index + Margin = Rate.

Also remember that we have a tremendous amount of ARMs in the US that are going to reset in the near future.

Normally, the LIBOR rate follows closely with the federal-funds rate, (which is the overnight lending rate managed by the Federal Reserve). So why is LIBOR going to be the new buzz word?  The two rates are now diverging, (Fed Funds and LIBOR).  Yesterday, the rate hit 5.7%, marking the rate's fastest rise in several years!  That caught the attention of many in the know as well and in doing so the news media.

Why did it bump so dramatically? 

Here's a great quote I found,

"One reason the LIBOR is trading so high is that banks, many of them in Europe, have heavy commitments tied to struggling commercial-paper markets. They are reluctant to lend out dollars, and that is driving up short-term borrowing rates. Some are also worried that their counterparties in these trades, other banks, might be too weak to pay back the loans!"

Lock that last statement into the back of your mind.  Too weak to pay back loans?  The LIBOR is short term right?  Overnight to 12 months out.  These big multinational banks are worried that other big multinational banks might not be able to cover their payments in the over the next year?

So now you know more than the guy in next cubicle about LIBOR.  Heck, you may now know more about LIBOR than your last loan officer.  That's a scary thought isn't it?