Libor dollar rates drop amid stepped-up bank rescues

By Gavin Finch
Bloomberg News
Monday, October 13, 2008

http://www.bloomberg.com/apps/news?pid=20601085&sid=aRZTg5IzBnI0

LONDON -- Money-market rates in London fell after policy makers offered banks unlimited dollar funding and European governments pledged to take "all necessary steps" to shore up confidence among lenders.

The London interbank offered rate, or Libor, for three-month dollar loans dropped 7 basis points to 4.75 percent today, tied for the largest drop since March 17, the British Bankers' Association said. The one-month dollar rate declined to 4.56 percent, while the one-week euro rate fell to 4.34 percent, the BBA said. There was no overnight dollar price today because of the Columbus Day holiday in the U.S.

The Federal Reserve said today central banks around the world will offer as much dollar funding as required. Leaders of the 15 nations using the common currency agreed yesterday to guarantee new debt from financial institutions and use taxpayers' money to keep lenders afloat. The three-month rate banks charge for euro loans dropped by the most since Dec. 28.

"Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses that have prevailed in commercial paper and inter-bank markets," a team including Dominic Wilson, senior global economist at Goldman Sachs Group Inc. in New York, wrote in an investor report today. "This is because bank solvency risk should decline as the government offers protection."

... Markets Frozen

Credit markets remained frozen last week even as policy makers jointly cut interest rates for the first time since 2001 and continued to inject cash into the banking system. The Group of Seven nations pledged measures at the weekend to stem a market panic that sent the MSCI World Index of stocks plunging 20 percent last week. Stocks rallied today, with the index jumping the most since Sept. 19.

The Fed, ECB, Bank of England and Swiss National Bank will hold one-week, one-month and three-month dollar auctions at a fixed interest rate, the Washington-based Fed said on its Web site today. Central banks "can provide U.S. dollar funding in quantities sufficient to meet their demand" into 2009, it said.

Three firms are finalists to be the U.S. Treasury's "master custodian" for Secretary Henry Paulson's program to aide financial institutions, Treasury Assistant Secretary Neel Kashkari said. Paulson's program to buy equity in these companies will be optional and aimed at "healthy" firms, Kashkari, who oversees the $700 billion Troubled Asset Relief Program, said in Washington today. The selected firm will be announced within 24 hours and will serve as the program's prime contractor, he said.

... Loan Guarantees

The three-month dollar rate is still 325 basis points more than the Fed's target of 1.5 percent. The difference was a record 332 basis points on Oct. 10. The rate was 82 basis points more than the Fed's target on Sept. 15, the day Lehman Brothers Holdings Inc. collapsed.

"Policy officials have won this fight, but not the war," said Lena Komileva, head of G7 Market Economics at Tullett Prebon Plc in London. "Risks remain and it's crucial that governments move ahead with recapitalization and the introduction of bank debt guarantees soon. It is early days still, but the freeze is starting to thaw."

France, Germany, Spain, and Austria today committed 1.1 trillion euros ($1.5 trillion) to guarantee bank loans and take stakes in banks equal to 3 percent of their economies, racing to prevent the collapse of the financial system.

Germany has pledged 400 billion euros in loan guarantees and set aside 20 billion euros to cover potential losses. It will also provide as much as 80 billion euros to recapitalize banks. France will guarantee 320 billion euros of bank debt and set up a fund that could spend up to 40 billion euros. Spain's government will guarantee up to 100 billion euros of bank debt and buy shares in banks in need of capital.

... 'Restore Faith'

"Extraordinary measures are necessary under such extraordinary market conditions," the German Finance Ministry said in an e-mailed statement. "The central task is to restore faith between market participants."

In Hong Kong, where the government has refrained from guaranteeing bank debt, interbank lending rates stayed at the highest in a year. The three-month rate climbed 3 basis points to 4.44 percent. Singapore's three-month dollar loan rate increased for a fifth day, rising more than 5 basis points to 4.79 percent. That's the highest since Dec. 27.

The dollar Libor-OIS spread, a gauge of demand for cash, narrowed 4 basis points to 360 basis points. It was at 105 basis points on Sept. 15. The spread was 24 basis points on Jan. 24.

... Guessing Libor

Libor, set by 16 banks in a survey conducted by the BBA each day in London, determines rates on $360 trillion of financial products worldwide, from home loans to derivatives. Member banks provide estimates on how much it would cost to borrow in 10 currencies for terms between one day and a year.

While the estimates that go into Libor used to be based on actual transactions between banks, they have become little more than guesswork since credit markets froze, three people with knowledge of how interbank rates are set said last week.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, narrowed 7 basis points to 457 basis points, down from the most since Bloomberg began tracking the data in 1984.

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