In the past few weeks, Libor — the influential composite of short-term borrowing costs for some of the world's largest banks — has risen sharply, reflecting Europe's debt tremors.
For consumers, in turn, the spike adversely affects a variety of loans in this country, not least of all home mortgages; the index is the primary benchmark used to determine rates on most jumbo loans now issued, and it underlies many of the subprime loans issued during the boom. Libor's fluctuations also determine the monthly rates on many commercial loans here.
With the U.S. economy showing signs of a fledgling recovery, some now question whether it makes sense to enmesh the loan rates of U.S. homeowners and small businesses with the ill health of European financial institutions and governments. Compounding this, the European turmoil has also revived concerns about Libor's fundamental accuracy.
In a crisis that should be disproportionately affecting European institutions, the individual borrowing costs self-reported by the 16 banks that contribute to Libor have risen in near-lockstep. As the crisis worsens, this is creating seemingly implausible results.
According to the daily Libor survey, it is now safer to make a one-year loan to France's Societe Generale than it is to the Royal Bank of Canada, an institution whose home country is generally held to have made it through the financial crises of recent years with flying colors. Though the European contributors do report slightly higher borrowing costs on average than their non-European counterparts, the gap is neither wide nor growing.
"Either everyone's the same credit, or these numbers are rigged," said James Bianco of Arbor Research. "And I don't believe that everyone's the same credit."
The British Bankers Association, which compiles and licenses Libor, stands by the numbers and says it regularly confirms their accuracy with market participants. Just because banks do not tend to show sudden jumps relative to their peers does not mean that the numbers are a poor proxy for actual borrowing costs, the trade group said.
Often interbank lending is "based on long-term relationships rather than a bank going into the marketplace and saying, 'What am I good for?' " said John Ewing, a director of the association. "Since 2008, a lot of these banks are dealing more bilaterally."
Setting aside the question of how reliable its components are, Libor itself remains well below the heights it reached after the Lehman Brothers failure. And its rise is still small in absolute terms — the three-month index is up only 29 basis points since February.
Still, "all things being equal, you'd clearly prefer that households had a Treasury-linked mortgage," said Mark Schweitzer, who has researched the effects of Libor's previous spikes as research director at the Federal Reserve Bank of Cleveland.
His research has concluded that a period of heightened bank credit risk would cost Ohio homeowners tens of millions of dollars a year, but he and other observers see little evidence that borrowers are being sufficiently compensated for that exposure through slightly lower rates.
Banks hedge their positions regardless of whether their exposure is Libor- or Treasury-based, and as much as anything, the preference may come down to familiarity and habit.
Though large institutions prefer Libor, "you get institutions below $2 billion, a lot of them understand the Treasury markets so much better than Libor," said Peter Taglia, a vice president at First Horizon National Corp.'s FTN Financial Capital Assets Corp.
