In this era of low mortgage rates, few borrowers are opting for ARM loans. We all know that at some point that will change and lenders will all have to dust off their ARM margin notes and remember things like LIBOR, created in the 1980′s. The London Interbank Offered Rate is a key adjustable rate mortgage index, but also helps price trillions of dollars of derivatives and corporate loans.
Calculated daily, Libor (not all in caps) is supposed to measure borrowing costs for a panel of banks globally. The rate “floats,” or ebbs and flows depending on how much banks charge one another. At the height of the financial crisis in 2008, Libor was one of the most-watched indicators, as nervous investors looked at its sharp rise as a sign of waning confidence in the stability of the global financial system.
But these days two key Libor gauges are being suppressed because of sharply shrinking demand since banks have a lot of cash, and don’t need to borrow from each other. Libor rates are very low, and have failed to reflect turmoil in the bank markets amid the European debt crisis. (In the 2008 financial crisis, by contrast, the rate rose to about 4.82% from 2.81% in a six-week period.)
For consumers and companies, low Libor is good news because some home, student and corporate loans, among other things, are tethered to Libor. Just think of all those resetting ARM loans (although the impact depends on margins). Most U.S. auto and credit-card loans are set against the prime rate, however, which now stands at 3.25% and often have margins in the teens.
The British Bankers’ Association “oversees” Libor, and has some reasons why Libor is so low and why banks are borrowing less from one another in the Libor market. In the U.S. and Europe, regulators have given banks cheap access to their lending facilities since the 2008 panic. And depositors are parking their money in banks – who needs to borrow outside aside from banks with end-of-month funding needs? Retail deposits are desirable because they are stable. The Fed has a lot of cash now (which they could use to buy bonds) which also keeps Libor low: there is a massive liquidity cushion.