A reader asks:
Having read an article yesterday in the New York Times about the LIBOR rate running counter to most central banks' rates, I am wondering if the LIBOR rate remains the same, how would this impact not just subprime borrowers but central and corporate banks?To answer this question, I must first explain what the LIBOR rate is, how it works and why it is important. LIBOR stands for London InterBank Offered Rate, which is a guide world-wide for the rate banks use to lend to each other. In the U.S., it is usually not far off from the Fed Funds rate.
As a result of the 2007 Banking Liquidity Crisis, banks have become afraid to lend to each other, and so LIBOR has risen independently of the Fed Funds rate. The Fed is trying to lower LIBOR so banks can get back in the business of lending to each other, but it hasn't been working as well as the Fed would like. In fact, LIBOR may not return to its normal cozy relationship to the Fed Funds rate until the financial markets stabilize. (See Fed Governor Kroszner Says Credit Crisis May Not Be Over, 10/22/07)
How It Affects You
Most adjustable rate mortgages and credit card interest rates are based on LIBOR. As rates reset, the high LIBOR makes the monthly payment also higher. This will cause a financial hardship to you, if you have that type of mortgage.Even if you don't, and you pay your credit card in full each month, a higher LIBOR rate will reduce liquidity in the economy. This could trigger recession in 2008.
Comments
Hiya Kimberly:
Came across an interesting chart recently. Shows the relationship between 1- and 3-month LIBOR, the fed funds target rate and the U.S. Prime Rate:
http://www.wsjprimerate.us/usprimerate-vs-libor-vs-fedfundstargetrate-chart.htm
LIBOR went as high as Prime back in October when the credit crisis was at its worst.