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Author: Subject: The Problem With Interest Rates Now

Ultimate Peach





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  posted on 10/10/2008 at 12:48 PM
If you're wondering about this credit crunch thingy, here's another morsel to chew on.

Today, the 30 day LIBOR rate is higher than the prime rate. Historically, this is such an absurd thing to be writing, that I'm surprised there's no autocorrect feature on my PC to change it. Short term LIBOR rates are generally 200-300 bp below prime. In very simple terms, when banks lend each other money overnight to meet reserve or loan funding requirements, they do so at LIBOR plus some spread - so for most banks, their MARGINAL cost of funds is assumed to be slightly more than a short term LIBOR rate.

Some bank commercial and consumer loans are priced off prime. Prime to prime plus 1% are typical borrowing rates for most small-medium sized businesses.

So today, say you, Joe Smallbiz came to me for a loan. My marginal cost to fund that loan is LIBOR, or 4.58% and yet Prime is 4.5%. So if I lend you money at Prime, I lose .08%. A positive spread of 2.5% is considered adequate, 3.0% is good, above that excellent. So the cost of this company borrowing just went from Prime to Prime plus 2.5%.

If you're wondering why there is so much government intervention here and abroad to shore up banks, this is why. The LIBOR rate has to return to its historic level .

The worst part about this rate environment is that borrowers normally face higher interest rates in GOOD economies. Poor economies generally have falling rates, so it's creating a further drag on the economy.

 

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Zen Peach



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  posted on 10/10/2008 at 01:32 PM
Good info.

 

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Maximum Peach



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  posted on 10/10/2008 at 01:58 PM
Also, that libor rate is tied to may people's adjustable rate mortgages and hence the problem with millions of Americans unable to meet their mortgage payments.


 

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Maximum Peach



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  posted on 10/10/2008 at 02:03 PM
GAF: if I understand the current conditions with LIBOR, this is a trust issue. Don't you figure that once the dam starts to crack open just a little and banks starting lending to each other again AND getting repaid, this will adjust to the positive side again?

Seems to me that with a little confidence restoration, this will correct itself, no?

 

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  posted on 10/10/2008 at 09:17 PM
Thanks for the explanation.

I was surprised to see my bank offer CD rates above prime. 5% for 24 months and 5.25% for longer term. Of course my bank, National City Corp, is in need of money. With lots of cash on the "sidelines" they are likely trying to attract some their way. Haven't seen 5% CD rate on a relatively short term for a while.

 

Ultimate Peach



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  posted on 10/10/2008 at 11:31 PM
Rich, yes, it is definitely a question of trust. Someone, maybe here, I read so much of this stuff lately, drew an analogy that interbank lending has become like a poker game in which 2 of the 10 players cannot make good on their markers, but no one knows which 2. So everyone is cautious and only when the two are exposed, can the game return to normal. Hence the need for the Fed to flush this as quickly as possible.

I have heard that National City is in talks with potential suitors, but don't know how bad it is there.

[Edited on 10/11/2008 by Gregallmanfan]

 

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Maximum Peach



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  posted on 10/10/2008 at 11:41 PM
quote:
I have heard that National City is in talks with potential suitors, but don't know how bad it is there.


From all accounts I've heard it is pretty bad. I think they stand to benefit greatly from the federal "bailout" plan. I've read about some of the recent rumors. I've always been extremely happy with them, I just hope if (or when) they get bought things don't change too much.

 
 


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