Thursday, September 11, 2008

What is the value of LIBOR?


An ongoing issue in London and around the world is determining the value of LIBOR. This has been the gold standard for short-term benchmarks for all types of rate products yet the pricing that has been seen in the market over the last year has been crazy mix of anxieties about banks and credit that has created a significant amount of uncertainty.

The chart of the day provides a comparison with the overnight index swap rate for a number of currencies. It is amazing how stable these global relationships were a year ago. Now the numbers move back and forth on a daily basis especially relative to another benchmark for the overnight swap rate. This is even more telling when it is compared on a percentage basis relative to the absolute level of rates.

When you think about what could be done to help the financial markets, setting a better standard for lending rates should be at the top of the list. Former BOE official Willem Buiter is dramatic in his comment, but is correct in focusing attention on this problem. Of course, the markets are more volatile and these spreads should be moving around but a portion of the change is associated with the lack of clarity on what the price represents . If LIBOR can be a useful benchmark then it will be easier for all institutions and clients to appropriately set rates for the market.

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