I have been following measures of credit strains lately, and I have come across a couple of interesting observations on the LIBOR, which is at the heart of the most commonly used measures such as LIBOR-OIS and TED spreads.
I am not a finance whiz kid, so I cannot figure out how Fed's lending, which is secured by collateral, would be higher than LIBOR, which is unsecured: But this is exactly what happened on Monday: At the Fed's auction of 28-day lending through its TAF, the stop-out rate was 3.75%, while the one-month LIBOR was around 3.20% on Monday and Tuesday. There has been quite a bit of debate in the past few months on whether LIBOR is an accurate measure (WSJ ran an article on the subject back in May). Moreover, some of the rate in the auction is probably due to the high demand (USD 134bn for USD 75bn), but even a five-minute analysis of a simple regression of the TAF rate against the bid-cover ratio a couple of controls convinced me that oversubscription can only explain so much.
I plan to look at the determinants of TAF rates in more detail later on, as there is a more fundamental issue at stake here: While Central Banks are providing liquidity to ease credit strains, I am not sure how willing banks would be willing to borrow from the interbank market while they have easy access to central bank money, which is likely to increase whenever liquidity dries up. So there might be the familiar chicken-or-egg problem going on here. I hope to return to this issue after analyzing the data, but the basic message is that for a number of reasons, it might not be a good idea to make more out of LIBOR than what is really is: the rate at which banks offer unsecured funds in the London interbank market. Even if it is an accurate indicator of that, it might not be a good measurement of credit strains.
I am not a finance whiz kid, so I cannot figure out how Fed's lending, which is secured by collateral, would be higher than LIBOR, which is unsecured: But this is exactly what happened on Monday: At the Fed's auction of 28-day lending through its TAF, the stop-out rate was 3.75%, while the one-month LIBOR was around 3.20% on Monday and Tuesday. There has been quite a bit of debate in the past few months on whether LIBOR is an accurate measure (WSJ ran an article on the subject back in May). Moreover, some of the rate in the auction is probably due to the high demand (USD 134bn for USD 75bn), but even a five-minute analysis of a simple regression of the TAF rate against the bid-cover ratio a couple of controls convinced me that oversubscription can only explain so much.
I plan to look at the determinants of TAF rates in more detail later on, as there is a more fundamental issue at stake here: While Central Banks are providing liquidity to ease credit strains, I am not sure how willing banks would be willing to borrow from the interbank market while they have easy access to central bank money, which is likely to increase whenever liquidity dries up. So there might be the familiar chicken-or-egg problem going on here. I hope to return to this issue after analyzing the data, but the basic message is that for a number of reasons, it might not be a good idea to make more out of LIBOR than what is really is: the rate at which banks offer unsecured funds in the London interbank market. Even if it is an accurate indicator of that, it might not be a good measurement of credit strains.
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