The bailout has failed

Libor for Overnight Dollar Loans Jumps as Credit Freeze Deepens

Oct. 7 (Bloomberg) — The cost of borrowing in dollars overnight in London jumped as U.K. lenders held talks with the government on emergency funding and Iceland nationalized its second-biggest bank amid an unprecedented credit squeeze.

The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94 percent today, the British Bankers’ Association said. The corresponding rate for euros climbed 22 basis points to 4.27 percent, the highest in four days. The Tokyo interbank rate stayed at the highest level this year and the Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record.

“There’s still a massive lack of confidence in this market and the more we talk about it, the more it becomes a self- fulfilling prophecy,” said Jan Misch, a money-market trader in Stuttgart, Germany, at Landesbank Baden-Wuerttemberg. “Sentiment hasn’t improved much and rates remain at elevated levels.”

The seizure in global credit markets is deepening on speculation central bank attempts to revive lending between financial institutions won’t work, resulting in more bank failures. The Federal Reserve Board, invoking emergency powers, said today it will create a special fund to buy U.S. commercial paper to support the financing needs of corporations.

“This is a major step in freeing up capital at least to flow through to corporates,” said Brian Edmonds, head of interest rates at Cantor Fitzgerald LP in New York. “I don’t know if it is a watershed event but the Fed is providing tremendous amounts of liquidity and now they are hitting where the problems lie.”

Three-Month Bill

Government bonds fell after the Fed’s announcement. The yield on the three-month Treasury bill climbed 41 basis points to 0.87 percent. Yields on top-rated overnight U.S. commercial paper dropped 0.74 percentage point to 2.94 percent, according to data compiled by Bloomberg.

Earlier, Iceland said it was negotiating a 4 billion-euro ($5.44 billion) loan from Russia and took control of Landsbanki Islands hf, its second-largest lender, to stem a collapse of the nation’s financial system. The U.K. government may invest $79 billion in some of the nation’s banks to bolster their capital, two people familiar with the matter said.

The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, dropped 11 basis points to 277 basis points. Earlier, it rose as high as 292 basis points. The average was 8 basis points in the 12 months to July 31, 2007, before the credit squeeze began.

`Government-Led Injection’

“It’s shocking to see that the money market is still in the condition that it’s in, despite measures by central banks to unfreeze it,” said Vincent Chaigneau, head of foreign exchange and interest rate strategy Societe Generale SA in London. “A global government-led capital injection into banks may be needed.”

The major banks may need $675 billion in fresh capital over the next several years to recover from the credit crisis, the International Monetary Fund said. Losses tied to U.S. loans and securitized assets may amount to $1.4 trillion, the Washington- based lender said in its annual report on the financial system. Its estimate two weeks ago was $1.3 trillion.

Libor, set every morning in London, determines prices for financial contracts valued at $393 trillion as of Dec. 31, 2007, or $60,000 for every person in the world, and helps set consumer interest rates on everything from home loans to credit cards.

Banks yesterday lodged 42.6 billion euros in the European Central Bank’s overnight deposit facility, up from 38.9 billion on Oct. 3. They also borrowed 13.6 billion euros from the ECB at the emergency overnight marginal rate. The ECB’s deposit rate is 3.25 percent and the marginal lending rate is 5.25 percent.

Australian Rate Cut

Japan and Australia’s central banks pumped more than $11 billion into markets in an attempt to revive lending. The Reserve Bank of Australia also slashed its benchmark interest rate by a whole percentage point, twice as much as economists forecast, raising speculation policy makers around the world may act together to cut borrowing costs.

There is “speculation the Federal Reserve could announce new measures and that we could see coordinated rate cuts,” Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt, said before the Fed announcement. “I don’t think the cuts will happen as quickly as some people are expecting.”

The TED spread, or the difference between what banks and the Treasury pay to borrow money for three months, dropped to 344 basis points today, from 382 basis points yesterday and a record 391 points earlier.

Iceland Measures

Iceland, which had its credit ratings reduced by Standard & Poor’s yesterday, today pegged its currency to a trade-weighted index as it sought to contain a crisis that’s pushed the krona down as much as 31 percent against the dollar in the past 30 days. The central bank also gave a 500 million-euro loan to Kaupthing Bank hf, the nation’s largest lender.

Financial institutions have incurred $585 billion in writedowns and losses since the collapse of the U.S. subprime- mortgage market in early 2007. Governments in Europe and the U.S. arranged rescues for six financial institutions in the past two weeks.

The Tokyo three-month interbank rate held at 0.87 percent today, the highest since last year, and the corresponding rate in Singapore rose 1 basis point to 4.24 percent, near the highest since January. Taiwan’s overnight lending rate increased 8 basis points to 2.11 percent.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.netAndrew MacAskill in London at;

Last Updated: October 7, 2008 11:29 EDT
By Lukanyo Mnyanda and Andrew MacAskill

Source: Bloomberg

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