LIBOR Mess Promises to Squeeze ARM Borrowers

An international uproar over allegations that some banks intentionally manipulated LIBOR, a key interest rate used to determine rate adjustments for many adjustable-rate mortgage holders, is likely to have a real-world impact for many adjustable-rate mortgage borrowers, sources told Housing Wire Thursday. At the heart of the debate is a report by the Wall Street Journal, first published on April 16, that questioned the accuracy of the benchmark lending rate; the Journal provided evidence that suggested some major banks were helping keep reported LIBOR rates artificially low. See interactive charts. The WSJ Journal revisited the story on Thursday, ahead of adjustments to the LIBOR system that appear likely to be introduced by the British Bankers Association on Friday:

The Journal analysis indicates that Citigroup Inc., WestLB, HBOS PLC, J.P. Morgan Chase & Co. and UBS AG are among the banks that have been reporting significantly lower borrowing costs for the London interbank offered rate, or Libor, than what another market measure suggests they should be. Those five banks are members of a 16-bank panel that reports rates used to calculate Libor in dollars. That has led Libor, which is supposed to reflect the average rate at which banks lend to each other, to act as if the banking system was doing better than it was at critical junctures in the financial crisis.

The one-month and six-month dollar LIBOR is used to benchmark a large number of adjustable-rate mortgages in the U.S.; the one month rate has remained extremely low, currently at 2.46 percent, and has fallen dramatically from 5.22 percent just six months ago. The six month LIBOR follows a similar trajectory. The result has been an veritable erasing of any potential adjustable-rate payment reset shocks for 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). The WSJ estimates that an artifically-depressed LIBOR may have given homeowners and other consumer debtholders a $45 billion break through the first four months of this year. What happens with that sort of unintended stimulus vanishes? It’s not known exactly how many borrowers with adjustable-rate mortgages are tied to LIBOR, versus the yield on short-term Treasuries, but HW’s sources suggest that number could be as large as half of ARM borrowers. That number is likely even higher among subprime borrowers, our sources said. “We’ve got an entire class of borrowers right now that is absolutely dependent on LIBOR sitting low,” said one source, an MBS analyst who asked not to be identified by name. “Tinkering with the how the rate is calculated doesn’t seem likely to push it down, although I can see plenty of reasons it might jump upward.” The Journal, citing sources close to the BBA, said that any changes to LIBOR calculations aren’t likely to represent a “radical redesign.” Which means that — even if only for a brief moment — the interests of millions of subprime borrowers and those of the banking crowd are in alignment.

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