Learn You Some LIBOR

Great Donald MacKenzie piece in the LRB. Some excerpts..

"Libor anchors contracts amounting to some $300 trillion, the equivalent of $45,000 for every human being on the planet."

"As rates rose sharply in the 1980s, almost all the savings and loan associations in the US – the equivalent of the UK’s building societies – were caught out in this way. The resulting crisis, a precursor of today’s credit crunch, pushed more than 700 savings and loans into insolvency, and the rescue operation ended up costing US taxpayers around $130 billion."

"Given the criticism of Libor, why not abandon its conditional aspect (the submission of rates at which banks could borrow), and shift, as some critics have suggested, to an index based on actual transactions? At least two such indices already exist. Eonia (Euro Overnight Index Average), calculated by the European Central Bank, is a weighted average of the rates of overnight interbank loans denominated in euros. Sonia, its sterling equivalent, is a similar average of overnight loans transacted via London’s main money brokers."

Learn You Some TED, Fred!

(Note to the already initiated: skip this post.)

Ok, now that you know what a derivative is, here's what to watch this week and next: the Ted spread.

The Ted spread can be thought of as an indicator of credit risk. It measures the price difference between three-month futures contracts for U.S. Treasuries (aka, T-bills/the paper/loans that the FED is printing to raise/borrow all the billions it's injecting into the banks right now) and three-month contracts for Eurodollars (aka, LIBOR, London inter bank offer rate) having identical expiration months. This is because U.S. T-bills are considered risk free while the rate associated with the Eurodollar futures is thought to reflect the credit ratings of corporate borrowers. As the Ted spread increases, default risk is considered to be increasing, and investors will have a preference for safe investments. As the spread decreases, the default risk is considered to be decreasing. (Some investopedia copy-and-pasting in the this paragraph.)

While the headlines are dedicated to the DOW, it's really all about the Ted, right now.

So, here's the Ted now (and you can track it here)...

Market's Up, And?

Yes, DOW's up, but the underlying problems are serious and will remain for some time. And it's not clear yet what this means for equity markets in the short- and near terms. If equity prices are currently 'undervalued' (assuming that they will be 'corrected' to some golden-rule P:E/EBITDA ratio), then one would expect to see more people moving into the market than we see now.

As a general measure, take the terms of Buffet's investments in GE and Goldman Sachs. Yes, he put in some billions, but the more aggressive the terms, the less bullish he is, really. He's not pouring cash into general equities at the moment, instead, GE and Goldman drew up these insanely privileged contracts for a new class of shares, all his own, with a generous dividend and almost infinite options.

The questions now are:

1. Now that the banks have FED capital, when, and how far will LIBOR rates drop? (Meaning, When will the banks start trusting, and loaning to, each other, regardless of the spin that's being given to the general public at the moment?)
2. How honest will the banks be in stating their losses in the next earnings report?
3. How aggressively will the Financial Accounting Standards Board enforce the rules on valuing the toxic assets in the next round of earnings reports? (Meaning, When will the charade end, and when will finally know what debt's good and what debt's bad?)
4. As the FED racks up more debt (DOWWTF?! earlier predicted that the final tab will come in at $1.5 trillion, though that's now looking kinda low), who will keep buying the T-Bills?