Libor Is Once Again Reflecting Problems

The Libor rate is once again signaling problems, but this time it is unclear who has the problem (see WSJ article). Just a few months ago there was some concern that Libor was understating the true borrowing cost (see previous posts here and here). Since the British Bankers' Association collects data from banks regarding their borrowing costs, it was speculated that banks were reporting costs that were actually lower than their true cost, mainly to keep from signaling to the market that others might be worried about potential problems with their company (ie., forcing higher lending cost). Now on Monday of this week, the rate for the 28-day Federal Reserve lending was 3.75 percent, higher than the one-month dollar Libor rate of 3.19 percent. This would normally not make sense given that the Federal Reserve requires collateral to secure the loans, whereas the short-term Libor lending between banks does not. Of course, within the last week Treasury yields have nearly disappeared as investors moved cash from money market funds to Treasuries after worries of some money market funds "breaking the buck." No doubt that as the government continues to debate possible bailout plans, and the Federal Reserve continues to find new ways to inject liquidity, anomalies such as what is being observed in credit markets will continue to keep investors scratching their heads and looking for safe places to park their money.