Bernanke Baffled by Libor
Saturday, May 3rd, 2008Friday morning’s surprise move by the Fed to inject dollars into the ECB and Swiss central bank was questioned by European central bankers. As reported by the Financial Times:
“The moves were initiated by the Fed, which believes that many of the strains in the dollar money markets reflect pressure from European banks that are structurally short of dollars. This view is questioned by European central bankers, but they agreed to take part. The Bank of England did not participate.”
To lower the US Fed Funds rate, Bernanke just clubs it over the head. But an international rate like Libor? Not so easy. And now we see that the central bankers themselves aren’t even sure why Libor is being so stubborn.
Chairman Bernanke needs to get the Libor rate down to try and stop the continuing collapse of the real estate market since mortgage rates are tied to Libor. Mortgage rates initially fell as the Fed began cutting rates, but have bounced back up recently.
Bernanke is trying to fight credit contraction, which is a market phenomena. The Libor rate is higher than the Fed Funds rate because of supply and demand in the international market. Libor is higher either because there lots of banks desperate for loans from other banks (high demand), or because banks in good shape are reluctant to loan to shaky banks (less supply). Or both.
Bernanke is willing to do what it takes to get Libor down, but I don’t think it will ever be politically acceptable for the Fed to inject money into foreign economies by buying huge amounts of their bonds as the Fed does in our market. So, Bernanke will never have direct control over Libor.
And Libor continues to defy. Last week, the Fed lowered rates by 0.25%, but Libor only fell by 0.14% and remains stubbornly at 2.77%, substantially higher than the Fed’s 2.00% rate.
So far, mortgage rates are rising in defiance of the Fed. The enormous number of empty houses in inventory will probably be with us for quite a while. Is it any wonder that home-builder stocks are not participating in this rally?
