LIBOR Not Treasury Rates Hurting SubPrime Borrowers

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The Federal Reserve is in a bit of a pickle. They lowered short term borrowing rates a quarter point yesterday to ease concerns of the subprime crisis, but many of these borrowers are essentially unaffected by the reductions.

That is because their loans are based upon the Libor rate. Libor, short for London interbank offer rate, is what 99 percent of the subprime loans and 38 percent of the Alt-A loans are based upon. And that spells trouble for the borrowers of these loans looking to refinance.

While treasury rates have dropped significantly, nearly 2 points, the Libor rate has barely moved, down only a quarter point. This means loans based on the Libor rate will adjust at nearly a 2 point difference.

So while the Federal Reserve is doing all it can to head of the tremendous amount of adjustable loan resets on the horizon, their hands are tied by the adjustable rate loans being tied to the Libor rates. And in Europe they are facing a very strong currency and economy so there is not a big incentive right now to lower interest rates.

Libor, which is an interest rate banks charge on loans to each other, normally tracks the federal-funds rate closely. But continuing worries over the credit crisis have kept Libor unusually high — partly because banks are reluctant to lend to one another — even as other short-term interest rates have fallen in recent months. The U.S. dollar three-month Libor yesterday was 5.11%, down from 5.36% in late June. Over the same period, three-month Treasury bill yields have fallen much more steeply, to 2.95% from 4.8%. “The Libor spread is screaming that there is a big, big stress point in the banking system,” says James Bianco, president of Bianco Research LLC, a market-research firm in Chicago. WSJ.com.