Libor's Biggest Drop Fails to Match Fed Rates, Spur Bank Loans

By Gavin Finch

Nov. 5 (Bloomberg) -- Credit markets are still creaking even after the biggest decline on record in the rate banks say they charge each other to borrow dollars.

The London interbank offered rate, or Libor, for three-month loans fell to 2.71 percent yesterday, from 4.82 percent on Oct. 10. The rate is still 171 basis points more than the Federal Reserve's target interest rate for overnight bank loans, compared with an average of 22 basis points in the five years before the global credit crisis began in August 2007.

``Banks are cutting back, the economy is in a deepening recession and in that environment, I don't think banks are going to become a lot more willing to extend credit soon,'' said Jan Hatzius, chief U.S. economist in New York at Goldman Sachs Group Inc., the world's biggest securities firm.

Government bailouts totaling about $3 trillion, interest- rate cuts around the world and unprecedented cash injections by central banks drove money-market rates lower in the past month without convincing financial institutions to lend. About 85 percent of U.S. banks tightened lending standards on loans to large and mid-size companies in the past three months, the Fed said on Nov. 3, the highest since the survey began in its current format in 1991.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said yesterday conditions remain ``highly challenging.'' Mike DiGiovanni, General Motors Corp.'s chief sales analyst, said a day earlier the scarcity of lending led to the automaker's worst month since World War II. The U.S. economy, which contracted 0.3 percent in the third quarter, may stay in a slump through 2009, Fed Bank of Dallas President Richard Fisher said Nov. 3.

Lehman Failure

The credit-market seizure that began after BNP Paribas SA halted withdrawals on three hedge funds last year worsened when Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, driving dollar Libor up 200 basis points, or 2 percentage points, in the next 25 days to the highest level in 2008.

The difference between Libor and the overnight indexed swap rate, a measure former Fed Chairman Alan Greenspan uses to gauge the state of money markets, was at 210 basis points yesterday. That compares with 87 basis points on the last day before Lehman's collapse and an average 11 basis points in the five years before the crisis started.

``We're not out of the woods yet,'' said Jan Misch, a money- market trader in Stuttgart at Landesbank Baden-Wuerttemberg, Germany's biggest state-owned lender. ``Libor fixings are improving but it's too early to say that this pattern is being replicated in the actual money markets.''

$360 Trillion

Libor is the benchmark rate for $360 trillion of financial contracts worldwide from mortgages to company loans and derivatives, according to the British Bankers' Association, an unregulated trade group based in London. That equates to about $53,500 for every person in the world.

It's set by a panel of as many as 16 banks in a daily survey where members estimate how much it would cost them to borrow in 10 currencies for terms from a day to a year. The Bank for International Settlements said in March some lenders may have ``manipulated'' rates to keep from appearing like they were in trouble.

Central banks have driven money-market rates lower by offering financial institutions as much dollar funding as they need and acting in concert to slash interest rates. The Reserve Bank of Australia cut its benchmark rate 75 basis points yesterday, joining policy makers in China, Hong Kong, India, Japan and the U.S. in reducing borrowing costs in the past week. The European Central Bank and Bank of England will cut their key rates by 50 basis points tomorrow, according to Bloomberg surveys of economists.

`Novocaine to Markets'

While cutting the U.S. target rate during the past 13 months to 1 percent from 5.25 percent, Fed Chairman Ben S. Bernanke has created six loan programs channeling at least $700 billion in cash and collateral into money markets as of Oct. 22.

``The Fed is trying to give Novocain to the markets,'' said Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York. ``It's all about buying time.''

Central bank operations helped the MSCI World Index of stocks rise more than 20 percent since falling to a five-year low on Oct. 27. Company borrowing costs have also declined, with yields on the highest-ranked 30-day commercial paper, or CP, falling yesterday to the lowest level since 2004. The market, used by companies to cover daily expenses, grew last week for the first time since Lehman's collapse.

Limited Impact

Cash injections have had a limited impact because instead of lending the extra money received in auctions, some financial institutions are holding it on deposit with central banks. Banks lodged a record 280 billion euros ($355 billion) overnight with the ECB on Nov. 3. The daily average in the first eight months of the year was 427 million euros.

``The money-market players remain cautious but we're at least seeing an improvement and that's going to continue,'' said Vincent Chaigneau, head of foreign-exchange and interest rate strategy at Societe Generale SA in London. ``Transactions remain limited and we still have a dislocated market, but we're seeing a significant pullback'' in rates, he said.

In its quarterly Senior Loan Officer Survey, the Fed said about 95 percent of U.S. banks raised the costs on credit lines to large firms, and ``nearly all banks'' increased the spread on borrowing rates over the cost of funds on loans to firms from July. About 70 percent of U.S. banks indicated they tightened standards on prime mortgage loans.

Passing on Rates

Banks may not pass all of the benefits of lower interest rates on to consumers and businesses. Banks around the world are re-evaluating the price they put on risk, raising the cost of loans when compared with levels of pervious years, said David Hodgkinson, chief operating officer of HSBC Holdings Plc, Europe's biggest bank.

``Credit has to be priced appropriately to reflect the risk,'' Hodgkinson said in a Nov. 3 interview in Abu Dhabi. ``If interest rates are brought down significantly, then rates for borrowers will come down. But I'm not going to say it's absolutely linear because it depends on the particular transaction and the risk.''

In another sign that lending remains restricted, corporate bond sales in Europe dropped in October to the lowest level this year, with 25.4 billion euros ($32.3 billion) of notes sold, compared with 35.9 billion euros in September, according to data compiled by Bloomberg. U.S. investment-grade offerings fell to $21.6 billion, the least since July 2002.

``No one wants to lend because they are still wary of values of bank balance sheets, and no one wants to borrow from the money market because they can borrow directly from the central banks,'' said Alessandro Tentori, a fixed-income strategist at BNP Paribas SA in London. ``In effect, the measures taken by central banks are not providing incentives to go into the interbank market.''

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net