Questioning the Accuracy and Relevance of a Key Interest Rate
CHICAGO, April 29, 2008 — "In recent weeks, one of the most important benchmarks for interest rates, the LIBOR, has come under intense scrutiny. Persisting stress on money markets has resulted in a misalignment of rates, thus complicating the mission of the Federal Reserve to restore calm and steer the economy away from a recession," says Adolfo Laurenti, senior economist of Mesirow Financial, in his April issue of Themes on the Global Markets.
"At the same time, doubts have been raised whether the LIBOR correctly reflects underlying fundamentals in the market for bank funds," notes Laurenti.
In his April newsletter, Laurenti addresses questions and controversial issues surrounding use of the LIBOR as a market indicator, including:
- What is happening to the LIBOR? – As the need for liquidity heightens, banks begin to increase their bid for overnight funding, thus driving a wedge between the LIBOR and the fed funds rate. This was the case during the second half of 2007, when money and credit markets seized up, and again in March and April, suggesting that the liquidity position of major banks may be worsening.
- What does an increase in the LIBOR mean for the economy? – Central banks pay attention to the LIBOR for two reasons. First, a spike in the LIBOR immediately translates into higher-than-necessary rates on a broad spectrum of existing loans. Second, a rate increase could substantially mute the impact of monetary stimulus provided by the Federal Reserve.
- Should we trust the accuracy of the LIBOR? – Until a few weeks ago, there was little effort to pry open the "black box" of the LIBOR. Even with evidence of widening spreads, the assumption was that the British Bankers' Association (BBA) numbers provided an accurate picture of market conditions. That confidence has now been shattered.
- What threats does an inaccurate LIBOR pose? – Some banks surveyed are suspected to have altered their reporting to the BBA in an effort to conceal the severity of their own liquidity problems. If, and this is a big if, some "strategic" reporting did take place and the LIBOR was misleading the market about the true cost of money, the implications for the economy and for policymakers are very relevant.
"The LIBOR is a thinly traded and highly inaccurate measure of market liquidity. In recent weeks, the United States has paid a particularly large price for its shortfalls as a market indicator, when problems in Europe have resulted in higher borrowing costs domestically," concludes Laurenti.
The April issue of Themes on the Global Markets as well as archived issues can be found at www.mesirowfinancial.com.
Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employee-owned firm with $31.4 billion in assets under management and more than 1,100 employees in 30 locations across the country and in London. With expertise in Investment Management, Investment Services, Insurance Services, Investment Banking, Consulting and Real Estate, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals and was named one of Chicago's Best Places to Work by Crain's Chicago Business in 2008. For more information about Mesirow Financial, visit its Web site at www.mesirowfinancial.com.
For more information, contact: Adolfo Laurenti, Mesirow Financial, 312-595-7129.
The Mesirow Financial name and logo are registered service marks of Mesirow Financial Holdings, Inc., © 2007, Mesirow Financial Holdings, Inc. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed are subject to change without notice. It should not be assumed that any recommendations incorporated herein will be profitable or will equal past performance. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy an interest in any Mesirow Financial investment vehicle(s).
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