LIBOR rate jump concerns banks

September 30, 2008 7:39:05 PM PDT
The London Interbank Offered Rate index was established in 1984, in London by British bankers. It is the interest that banks charge each other for loans, the most common being the overnight rate.

"Let's say a lot of people wanted money to take out of the ATM before the weekend on a Friday and the bank, instead of having to sell some of its assets, it could just go to another bank and say 'I just need $100 million tonight, lend it to me overnight,'" Marketwatch reporter Alistair Barr said.

Imagine the shock banks got Tuesday morning, when the LIBOR rate went up from 2.56 percent to 6.88 percent.

Tuesday's jump was in response to the failed congressional bailout and the resulting stock market crash.

The short term lending market is practically frozen; banks all over the world are sending other financial institutions the message, 'we simply don't trust you.'"

"One bank will not lend to another bank right now because there is no certainty about the following day; when you wake up will that bank you loaned to yesterday still be a bank," dean of the University of San Francisco Mike Duffy said.

What most Americans fail to realize is many U.S. adjustable rate mortgages are linked to the LIBOR index, as are most subprime home loans.

"For those people who are just coming out of the fixed-rate period, if we see big jumps in LIBOR, it's going to take a big bite out of whatever money they have," former president of the California Association of Mortgage Brokers Leon Huntting said.

The good news is people's mortgage rates do not reset every day, Duffy said.

"So today's enormous spike is not going to change anyone's mortgage today, but if it stays this high, in a few months many people would see their mortgage payments go up," he said.

Mortgage analysts say the LIBOR will begin to correct itself only after the U.S. is able to stabilize its banking industry.