LIBOR is in Backwardation and Significantly Divergent from Effective Fed Funds

LIBOR has ceased to function as a reliable benchmark suitable for commercial and residential loans in terms of US dollars.

It is in backwardation with an inverted yield curve, and has significantly diverged from the Effective Fed Funds rate.

This is most likely because of the Eurodollar 'short squeeze,' as shown by the record TED spread, and the inappropriately small sample size of LIBOR reporting banks.

This is all a symptom of the greater issue of the US dollar, which is no longer suitable as the reserve currency for global central banking.

The Federal Reserve is no longer able manage the dollar to simulate the stability of an external standard, given their decision to ignore nominal money supply growth. Their current mandate instead focuses them on purely domestic economic metrics that may be inappropriate for the changing state and requirements of exogenous economic systems, unless those systems are willing to subordinate their fiscal and monetary discretion.


What is LIBOR?

The London InterBank Offered Rate, or LIBOR, is the average interest rate charged when banks in the London interbank market borrow unsecured funds from each other.

There are different LIBOR rates for numerous currencies, including U.S. dollars.

The world banking system has adopted the LIBOR as a benchmark for short-term, interbank loans.

The LIBOR rates are now internationally recognized indices used for pricing many types of consumer and corporate loans, debt instruments and debt securities across the globe, and is the reference for many loans including the vast majority of Interest-Only Loans in The United States.

LIBOR rates are fixed every UK business day by the British Bankers' Association BBA.

The Fed Funds Target Rate, America's benchmark interest rate, and the U.S. Prime Rate are managed by America's central bank: the Federal Reserve.

The LIBOR rates, however, are fixed by a relatively small group of large private international banks themselves

The Bank of America
JP Morgan Chase
Citibank, NA
Bank of Tokyo-Mitsubishi UFJ Ltd
Barclays Bank plc
Credit Suisse
Deutsche Bank AG
HBOS
HSBC
Lloyds TSB Bank plc
Rabobank
Royal Bank of Canada
The Norinchukin Bank
The Royal Bank of Scotland Group
UBS AG
West LB AG


Is LIBOR a stable benchmark of short term money rates?

There is a case to be made that LIBOR is an inappropriate reference to be used for commercial short term rates because it is subject to distortions given the relatively selective sample size of the reporting banks. One or two troubled banks can significantly impact average LIBOR.

The spreads between the highest and lowest quoted rates in an efficient measure should be narrow and convergent. Recently the spreads among the LIBOR quoting banks have become shockingly wide, reflecting the non-competitive nature of the short term interbank loans given the massive intervention by the central banks as they flood the markets with loans designed to recapitalize the banking system.




Here is the detail of the composition of the 3 Month LIBOR. One might expect this to be a scorecard of default risk amongst the reporting banks from the perspective of their peers.





How does LIBOR compare to a short term rate measure such as Effective Fed Funds?

There has been a strong correlation between the Effective Funds Rate and LIBOR dollar rate as one might expect.



However, recently there is a growing divergence between LIBOR $US rates and the Effective Fed Funds Rate. This is a symptom of distress in the banking system and shows the inappropriate character of LIBOR for use as a benchmark for the commercial and residential loans markets.




And perhaps most surprisingly, the LIBOR dollar rate curve is now inverted.


How can LIBOR be Inverted when the Effective Fed Funds Rate is steepening?

This is most likely a symptom of fear of risk of capital return in interbank lending. It may also be a sign that the current eurodollar short squeeze is expected to dissipate, as it will as the capital markets revert to the means and efficient operation.



One might also pointedly ask what the G7 will be doing to address the distortions being introduced into the European banking system by the US dollar and its shortages due to the precipitous deterioration of US dollar debt assets held by European banks, as the solution for this seems to be eluding the bureaucrats in Brussels.

As a hint, the US dollar, like LIBOR, is being used inappropriately and the basis for international trade must change to a more stable measure.

Wall Street Bailouts Push 2009 Budget Deficit Estimates to a Record 12.5% of GDP

The new welfare queens, the Wall Street bankers, put all other non-military government programs to shame.

All holders of US dollars are going to be paying for this.

Taxation without representation is ... crony capitalism and dollar hegemony.

Cost of U.S. Crisis Action Grows, Along With Debt
By Matthew Benjamin

Oct. 10 (Bloomberg) -- The global financial crisis is turning into a bigger drain on the U.S. federal budget than experts estimated two weeks ago, ballooning the deficit toward $2 trillion.

Bailouts of American International Group, Fannie Mae and Freddie Mac likely will be more expensive than expected. States are turning to Washington for fiscal help. The Federal Reserve said this week it will begin buying commercial paper, the short- term loans companies used to conduct day-to-day business, further increasing costs. And analysts now say the $700 billion bank- rescue plan passed by Congress last week may have to be significantly larger. (You are not really surprised at this are you? - Jesse)

``I always assumed they would be asking for more money along the way if it was necessary, and it looks like it's going to be necessary,'' said Stan Collender, a former analyst for the House and Senate budget committees, now at Qorvis Communications in Washington. ``At the moment, there's nothing happening here that's positive for the budget. Nothing.''

The 2009 budget deficit could be close to $2 trillion, or 12.5 percent of gross domestic product, more than twice the record of 6 percent set in 1983, according to David Greenlaw, Morgan Stanley's chief economist. Two weeks ago, budget analysts said the measures might push deficit to as much as $1.5 trillion.

Yields to Rise

That means a lot more borrowing by Treasury, which will push up interest rates, said Greenlaw. ``The Treasury's going to be ramping up supply dramatically over the course of coming months to meet this enormous federal budget obligation,'' Greenlaw told Bloomberg this week. ``The supply will trigger some elevation in yields.''

Treasuries have fallen the past four days even as stocks sank, a sign investors are preparing for bigger U.S. government borrowing. Benchmark 10-year note yields rose to 3.82 percent at 7:49 a.m. in New York, from a close of 3.45 percent Oct. 6.

Payments the government allocated to keep vital companies solvent are beginning to look insufficient.

AIG, the giant insurance company that was taken over by the government in mid-September, said this week it may access $37.8 billion from the Federal Reserve Bank of New York, in addition to the $85 billion the government already loaned it to stave off bankruptcy.

``You're in for a dime, you're in for a dollar on this one,'' said David Havens, a credit analyst at UBS AG. (And boy don't these jokers know it - Jesse)

The financial health and earnings prospects of Fannie Mae and Freddie Mac -- seized by the government on Sept. 7 to prevent them from failing -- worsened in the second and third quarters, the companies' government regulator said this week.

Price Declines

The companies and regulators are recalculating the value of all of their assets to factor in price erosion. That may mean the government will have to spend more to keep the firms solvent.

Earlier this week the Fed announced it will create a special fund to buy commercial paper, the credit that businesses use to finance payrolls and other ongoing expenses. The Treasury will deposit money into the Fed's New York district bank to help set up the new unit. A Fed official said Treasury funding for the program could be ``substantial.''

California, Alabama and Massachusetts are urging the Fed and Treasury to include their securities in rescue plans designed for banks and businesses. The $2.66 trillion U.S. market for state and city bonds has been all but frozen since Lehman Brothers Holdings Inc., weighed down by losses in mortgage-backed bonds, declared history's largest bankruptcy on Sept. 15.

California has said it needs to sell as much as $7 billion in notes to maintain its schools, health system and other public services. The Bush administration said it is reviewing the states' financial positions.

Plan for Banks

Meanwhile, Treasury Secretary Henry Paulson indicated two days ago that he is considering buying stakes in a wide range of banks in coming weeks to help recapitalize them.

Such a move is allowed under the $700 billion bailout package Congress passed last week. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, said such action is necessary -- and will likely turn out to increase the measure's cost. Spending beyond the amount set in last week's bill would require further Congressional approval.

``We have to recapitalize the banks,'' Phelps told Bloomberg Television this week. ``I don't imagine that there's enough money in the first Paulson plan to be able to do all that needs to be done in that direction.''

The additional borrowing could push the national debt well past 70 percent of GDP, the highest since the immediate aftermath of World War II, when the U.S. was still paying off war debt....

SP Long Term Charts and the Reckless Adventurism of the Greenspan Federal Reserve

This chart shows the extreme effects of the Greenspan Federal Reserve on the stock market as a representation of its profound impact on the US economy, if not that of the world. Reckless adventurism may be too kind a description.

Two asset bubbles, back to back, were caused by the irresponsible expansion of credit and the lack of regulatory oversight of the banking system. This fostered malinvestment and a terrific destruction and reallocation of wealth.

This is what happens when the Fed takes its eye off the growth of money supply and credit, and instead focuses on exotic metrics and statistical rubbish, to the cacaphony and flourishes of pseudo-scientific oratory that confounds common sense.

There will be significant human dislocation and misery to come as the economy readjusts to more sustainable growth patterns and capital allocation.

Near term support levels are more obvious when looking at this chart below.

What we have are two neatly nested Head and Shoulders tops, at least.

Lehman Auction Sets up Largest CDS Settlement of $270 Billion

Bloomberg
Lehman Credit-Swap Auction Sets Payout of 91.38 Cents
By Shannon D. Harrington and Neil Unmack

Oct. 10 -- Sellers of credit-default protection on bankrupt Lehman Brothers Holdings Inc. will have to pay holders 91.375 cents on the dollar, setting up the biggest-ever payout in the $55 trillion market.

An auction to determine the size of the settlement on Lehman credit-default swaps set a value of 8.625 cents on the dollar for the debt, according to Creditfixings.com, a Web site run by auction administrators Creditex Group Inc. and Markit Group Ltd. The auction may lead to payments of more than $270 billion, BNP Paribas SA strategist Andrea Cicione in London said.

While the potential payout is higher than 87 cents on the dollar suggested by trading in Lehman's bonds yesterday, sellers of protection have probably written down their positions and put up most of the collateral required, said Robert Pickel, head of the International Swaps and Derivatives Association. More than 350 banks and investors signed up to settle credit-default swaps tied to Lehman. No one knows exactly who has what at stake because there's no central exchange or system for reporting trades.

``I don't think it buries anybody,'' said Brian Yelvington, a strategist at CreditSights Inc., a bond research firm in New York.

Sellers are required to post collateral, or pledge assets, to the buyer of protection, known as the counterparty, on the other side of the trade if the value of their positions declines. Because Lehman's bonds had already fallen, that collateral has probably been posted, Yelvington said.

Pimco, Citadel

The list of participants in the auction includes Newport Beach, California-based Pacific Investment Management Co., manager of the world's largest bond fund, Chicago-based hedge fund manager Citadel Investment Group LLC and American International Group Inc., the New York-based insurer taken over by the government, according to the International Swaps and Derivatives Association in New York.

Hedge funds, insurance companies and banks typically buy and sell credit protection, which is used either to insure a bond against default or as a bet against the company's ability to pay its debt.

The payments ``are insignificant when put into the context of the trillions of dollars of payments that are made through settlement systems each and every day,'' Pickel said on a conference call with reporters today.

Fears `Overblown'

Some funds may be forced to dump assets to meet the payment demands if they haven't hedged, BNP Paribas's Cicione said.

``Banks can go to the Federal Reserve, or use the commercial paper market where it is still functioning'' to meet protection payments, said Cicione, who said a 9.75 cent recovery rate would lead to payments of about $270 billion. ``But fund managers or hedge funds, once they've used their cash, have only one option: to sell assets.....''