Changes to LIBOR Loom; Will Borrowers Feel the Squeeze?
On the heels of criticism from some market participants, the British Bankers Association on Tuesday announced a series of sweeping changes to the governance of its London Interbank Offered Rate. But it's the changes that the BBA said it is considering that seem likely to have most relevance for U.S. borrowers going forward. In a press statement, the BBA said that it would consider "whether the historically transparent rate-setting mechanism is stigmatising contributors and whether a second rate-fixing process for US dollar LIBOR might be set after the US market opening." The so-called dollar LIBOR is used to set rates for hundreds of trillions of dollars' worth of financial products, including adjustable rate mortgages. The BBA also said it would tighten scrutiny of rates contributed by the banks in the wake of allegations that LIBOR had been manipulated by banks' desire to prevent signaling weakness to market participants, by adding to the group that oversees the LIBOR rate-setting process; and the group said it would increase the number of reporting banks that are used to set the widely-used interest rate benchmark. Adding a second daily fixing to LIBOR -- one tied to the open of U.S. markets -- would likely lead to more volatility in the key index used to benchmark many adjustable-rate mortgages in the States, sources told Housing Wire Tuesday morning. Along with tightening oversight of the LIBOR reporting process, the changes being considered by the BBA seem likely to pressure rates to increase from their current historical lows. In fact, the three-month dollar LIBOR jumped 10 basis points to 2.79 percent on Tuesday after the changes were announced, the biggest such increase since August; further sustained increases are likely to reignite concern over ARM resets among lawmakers and consumer groups. ARM resets among subprime borrowers were the chief concern that led to the creation of the HOPE NOW coalition by Bush administration officials late last year. The dollar LIBOR is used to benchmark a large number of adjustable-rate mortgages in the U.S., and low LIBOR rates throughout most of 2008 thus far has led to a veritable erasing of any potential adjustable-rate payment reset shocks for most subprime and Alt-A borrowers — certainly a positive outcome for millions of potentially troubled borrowers, given that the U.S. is still facing a flood of subprime resets through the end of this year (Alt-A resets don’t begin in earnest until the middle of 2009, according to available data). Subprime mortgages are more likely to be tied to LIBOR than other adjustable-rate mortgages, sources told HW; prime and Alt-A ARMs tend to be tied to short-term Treasuries. The last major change to LIBOR came in 1998, when Japanese banks inflated the rates they contributed to the yen LIBOR.