Question on LIBOR rates

[matthylland]

So every time I turn on the TV or go to cnbc.com they are talking about the LIBOR rates (overnight, 1 month, 3 month).

I understand what they are, but I don't understand why they matter if the Fed's funds rate is much much lower (1.75% like it is now, compared to an overnight LIBOR rate at 5.09%)

Now I know right now only financial institutions are able to lend from the Fed...but why is someone not lending from the fed, and then lending that money out for a much higher rate, say 4.5%....under the LIBOR rate so they could find buyers, but they are still turning a safe, hansom profit.

I'm sure I am misunderstanding something here, any help?

 

[Mister Grieves]

It seems to me like every day something new is being blamed for the financial "crisis", and every time they try to take it out of the equation things get worse or stay the same.

 

[muh_roads]

Actually I'd like to know what they are.

 

[matthylland]

Actually I'd like to know what they are.

from CNBC.com:

"LIBOR is the London Interbank Offered Rate, the interest rate at which banks are willing to lend to one another."

so are banks only lending to other banks at that high of a price? or all companies??

Just FYI, a great site I found is investopedia.com I am pretty new with all this, and they have a very good site.

 

[forsmant]

The higher the rate the higher the risk of default. LIBOR is loans between banks, who would borrow at the higher rate when they can get the lower rate from the fed? Banks are afraid that they won't get their money back.

 

[matthylland]

The higher the rate the higher the risk of default. LIBOR is loans between banks, who would borrow at the higher rate when they can get the lower rate from the fed? Banks are afraid that they won't get their money back.

They are afraid they won't get their money back from the FED?

I understand the whole bank to bank part of it...I just don't understand why it matters if the Discount window is at a lower interest rate.

 

[Johnnybags]

Libor rates are what most credit cards are tied to

so of course keeping those high extracts the maximum from the people. I am sure they have zero interest in lowering our credit card rates despite what the idiots on TV tell you happens when the FED lowers.

 

[cjhowe]

The reason no one lends at a lower rate is because there is greater systemic risk. It is only a handsome profit if the other party repays the loan.

 

[surf]

London Inter-Bank Offered Rate - meaning what banks are charging each other for short-term borrowings.

many loans are tied to Libor - some mortgage backed securities and many other derivates as well.

there should be no doubt after looking at Libor rates that credit is available between banks in the capital markets at a "legitimate" price (interest rate).

the one prediction i've shared with friends is that deposit rates in the US will rise dramatically as banks compete for deposits.

 

[matthylland]

The reason no one lends at a lower rate is because there is greater systemic risk. It is only a handsome profit if the other party repays the loan.

But can they not lend for %1.75 percent from the FED?

Why do they need to pay 5% for loans from other banks in the first place?

 

[forsmant]

YOu mean certificate deposits? The ones that pay interest.

 

[forsmant]

But can they not lend for %1.75 percent from the FED?

Why do they need to pay 5% for loans from other banks in the first place?

They are not borrowing from each other or anyone else. They are expecting rough times ahead.

 

[dannno]

http://en.wikipedia.org/wiki/Yield_curve

Inverted yield curve

An inverted yield curve occurs when long-term yields fall below short-term yields. Under unusual circumstances, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. An inverted curve has indicated a worsening economic situation in the future 5 out of 6 times since 1970.

Generally long-term rates are higher than short-term rates because people expect a higher interest rate for giving up their money for a longer period of time.

Now, lets say rates are up around 16% and you want to invest some money for 5 years, but you expect that in 1 year the rates will be around 8%. You would settle for a 14% interest rate on a 5-year bond, even though other people are getting 16% interest rates on 3-month bonds.

 

[dannno]

It amazes me how intelligent finance people are, yet they can't figure out that our banking system is inherently fraudulent

 

[Cowlesy]

lol it's been answered on the board several times

SEarch function plus "LIBOR", in quotes, is your friend

 

[matthylland]

Ok, maybe I have a fundamental misunderstanding here...I am not asking what LIBOR rates are, or what the problem in today's economy is. I understand rates are higher because of the risk involved, or presumed.

The Discount window, from wikipedia:

The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.

Ok, this discount window is 1.75% right now, is that correct?

The overnight LIBOR rate is around 5%, meaning if Citigroup wanted a lend from Wells Fargo, the going rate for that loan is around 5%.

Why would Citigroup not go directly to the Fed, why are they going to other banks for loans?

 

[forsmant]

They aren't going to other banks. They are going to the fed.

 

[matthylland]

They aren't going to other banks. They are going to the fed.

Then why is the LIBOR rate even significant?

 

[surf]

Then why is the LIBOR rate even significant?

borrowing from the Fed window used to be a bad thing and, as someone mentioned, only utilized to cover an overnight error generally from some delivery failure or bad calculation - i know, i visited it a couple of times when my institution was required to keep a balance of only 2 or 3 million over 2-weeks, and we came up a million or so short on a day. banks are required to maintain a "reserve" balance at the Fed based primarily on the sum of their demand deposits.

you must file reports and sh#t like that with the Fed when you borrow, explain where and why the f#ck-up occured, and i hated being friendly with these guys. that's just an extra task that most didn't want to have to do, and just about every institution (used to) carry excess reserves in their FRB account (at a zero interest rate).

but the main point is that borrowing from the Fed window was seen as bad. banks sell fed funds to each other at the funds rate (1.5% now) and that is basically set by the FRB. i think what libor is telling everyone is that the fed funds rate (overnight loans between banks) is ridiculously low and out of touch with reality.

 

[matthylland]

borrowing from the Fed window used to be a bad thing and, as someone mentioned, only utilized to cover an overnight error generally from some delivery failure or bad calculation - i know, i visited it a couple of times when my institution was required to keep a balance of only 2 or 3 million over 2-weeks, and we came up a million or so short on a day. banks are required to maintain a "reserve" balance at the Fed based primarily on the sum of their demand deposits.

you must file reports and sh#t like that with the Fed when you borrow, explain where and why the f#ck-up occured, and i hated being friendly with these guys. that's just an extra task that most didn't want to have to do, and just about every institution (used to) carry excess reserves in their FRB account (at a zero interest rate).

but the main point is that borrowing from the Fed window was seen as bad. banks sell fed funds to each other at the funds rate (1.5% now) and that is basically set by the FRB. i think what libor is telling everyone is that the fed funds rate (overnight loans between banks) is ridiculously low and out of touch with reality.

Thank you!

I figured there was some sort of downside for borrowing from the Fed. I was thinking maybe there was just a limit of the amount of money...

thanks for the response