Banks Still Hoarding Cash Even as LIBOR Falls

The LIBOR rate, has fallen to its lowest level since 2004 in anticipation that the Federal Reserve will cut the Fed Funds rate to .25% next week. The LIBOR rate, which is the rate banks charge each other for overnight loans, is only 2%, down from the 5% heights it reached earlier this year. Despite cheap money, banks are still hoarding cash, indicating continued fear of lending to each other.

As LIBOR dropped, banks were still depositing 101 billion euros in the European Central Bank overnight depository. Although down from this fall's 200 billion euro level, it is still much higher than the normal 427 million euro level it held earlier this year. This means that banks are relying on central banks for their cash needs, instead of each other. That indicates a continued fear of inheriting bad debt from the subprime mortgage crisis. It seems that, until the world's governments absorb this debt or the banks have written it all down, credit markets will remain nearly paralyzed. (Source: Bloomberg, Dollar Money Market Rates Tumble on Fed Rate Cut Speculation, December 11, 2008)

What It Means to You

The good news is that most adjustable rate mortgages and credit card interest rates should start to drop, since they are based on LIBOR. However, normal liquidity has not returned to the world's economy, meaning that businesses can't get enough cash to operate their businesses. This is partly what has happened to the Big 3 auto companies. This will lead to further layoffs, store closures and business bankruptcies.

Related Reading

• Recession Frequently Asked Questions
• A Primer on the Role of Interest Rates in the U.S. Economy
• Understanding the Banking Crisis