LIBOR: "London InterBank Offered Rate"
It's what one London based bank will lend money to another London based bank.
To us, it's an index. This is all about London - why should we care?
Remember how ARM's work
An index is just something that we can all point to and agree upon. It's a factor that cannot be, or should not be manipulated. It is what it is. LIBOR is an index, so is COFI, MTA, or the 1 year Treasury. We generally all agree to use the same figure, as reported in the Wall Street Journal on such and such a day. That way we are all on the same page (pun intended).
To create a Adjustable Rate Mortgage we then take an Index (any index) and add a Margin to it. The Margin is just a number that the Lender adds to create the Note Rate. It does not correlate directly to profit margin.
INDEX + MARGIN = NOTE RATE
Simple enough right? While the Index may change, moving up or down, the Margin is the constant. It never changes. The ARM goes up or down depending on the movement of the index.
what if the LIBOR Index was manipulated?
Today, Bloomberg has an article reporting that London is cracking down on the banks that help create the LIBOR Index. It seems they've been fibbing. It has some pretty harsh quotes...
"The Libor numbers that banks reported to the BBA were a lie," said Tim Bond, head of global asset allocation at Barclays Capital in London. "They had been all along."
"Since the credit crunch, it's something that appears to have been manipulated," said Hahn, a former managing director at Citigroup. "We are in an extraordinarily delicate confidence time where a small event can shatter things quite easily."
Why is this so important to us here in America? This Index determines the interest rate of MANY consumer loans here in America. Not just a few exotic loans either.
- Most every Sub Prime Loan,
- Many A Paper ARMS,
- ALT-A Loans like the popular 3/1 or 5/1 Fixed Portion ARMS,
- And then there are the Payment Option ARMS or Neg Am Loans, many are tied to LIBOR as well.
So now, if London makes these banks tell the truth, you'll see LIBOR go up. That'll have implications for all those loans based on the LIBOR Index here. You know where I'm going with this...
We're all connected.
Comments(2)