by Jerome a Paris
Thu Oct 4th, 2007 at 11:14:59 AM EST
Is the storm over?
Another – potentially more pernicious – problem is the state of the interbank market. In recent weeks, the cost of borrowing funds overnight has dropped in Europe and the US as central banks have flooded the money markets with funds. However, in the three-month money market, rates remain very high because banks are apparently hoarding their funds rather than lending them out.
It also has troubling implications for investors: the interbank freeze in effect suggests that banks do not believe their own rhetoric that the outlook is improving. In public, in other words, they may seem upbeat but they are not putting their money where their mouth is.
This is not a very visible phenomenon, because it's happening behind the scenes, but banks are still deeply troubled - and, in effect, no longer trust one another. That's what the gap between the "3-month sterling libor" (the rate at which banks lend to one another) and the "base rate" (the rate they can get from the BoE for their extra liquidity) shows: it remains close to 100bps (basis points - hundredth of a percent) rather than the usual 25bps.
It was absolutely rational for Northern Rock clients to take their money out when other banks would not lend to the troubled bank, and it is just as rational today to take with a huge grain of salt what banks say about moving on after the crisis has subsized. It has not. And banks know it - or at least they show it, unwittingly or not, in their lending practices.