Overnight Libor

Overnight LIBOR is a part of the investment universe similar to the plumbing in the upstairs bathroom of your house. You never want to think or hear about it. While you think a lot of interior decorating, accent walls, and the color of your carpet or the stone counters in your kitchen, you only think about the plumbing when you have a problem, and water from the upstairs bathroom seeping into the second floor and threw the first floor ceiling can compromise the entire structure. It ruins the carpet, rots the walls, and can cause problems for years to come.

Overnight LIBOR is the rate at which banks charge each other for overnight loans. When we are talking LIBOR, we are talking about the biggest banks in the world. We are talking about the world's highest credit in any type of borrower. All lending, your car, student, home, and home equity loan, the financing on an exercise machine or a queen mattress are benchmarked off of LIBOR. The riskier the borrower, the higher the add on is to the LIBOR rate.

LIBOR is the foundation of lending, and the shortest loan is a one night loan. There is little to no risk when the world's highest credited borrower is taking out a one night loan right? Right now the annual rate on overnight LIBOR is 5.38%. FIVE POINT THREE EIGHT PERCENT annual interest to borrow money for one night. Two key elements of a loan determine how much interest you pay on a loan. These factors indicate the riskiness of a loan. Number one is the credit of the borrower. In overnight LIBOR the borrower doesn't get any more credit worthy. Number two is the length of the loan. The longer the term the more risk. Case in point, overnight LIBOR is one the least riskiest loans. 5.38% is absolutely shockingly high. The world cannot continue to function in a normal manner with LIBOR at this rate. We would like to see a 30 year fixed mortage in the low 6% range, but we are not going to get there on a 30 year loan to an individual American when overnight loans to the world's biggest banks are 5.38%. Think about the implications! Without reasonable financing home ownership will become even more out of reach, existing inventories of homes for sale nationwide will continue to rise, and prices will continue to tumble. Significant wealth destruction is occurring on Main St in the asset where Americans hold the largest component of their wealth...home equity.

I should mention a few asides. Overnight LIBOR is uncollateralized which slightly increases the risk, but the risk spread for that overnight is tiny. On the flip side, LIBOR is self reported by the banks so they are probably fudging a little on the low side. Case in point, you should round up that 5.38% to 6%.

If life with LIBOR at this rate continue, things will get very ugly very quickly in the world. With every HUGE government program introduced the market is able to bring back exceedingly shocking data to prompt more response. Ad hoc responses though of considerable size will no longer help alleviate the problem. The Fed cut rates by 50bps today to 1.5%, a 25% discount in the Fed Funds target rate, and LIBOR blew out to a new record!! That is unworldly and scary. That is some serious gloom in doom. I haven't looked at swap spreads but I heard they tightened which is some good news. I could get into swaps but I am waking up at 4:40am to go to work. After all, what am I going to tell my grandchildren about this? That I worked a normal day, 9-5? No, I'm gonna tell them I worked 14 hour days trying to figure out what the solution was.