The real-world consequences of an elevated Libor:
The average subprime borrower facing an adjustable payment for the first time next month would face a monthly payment increase of about 18 percent based on Libor rates as of Sept. 30, rather than the 10 percent that would have occurred based on the rates on Sept. 15, the analysts wrote. The payment would be $1,951, instead of $1,807, they said. Fannie Mae and Freddie Mac loans would be boosted to $1,021 on average, instead of $904.
Naturally, higher mortgage repayments mean more defaults. Not exactly what we need right now. On the other hand, the payment streams from those mortgages might well be higher than expected, which could at the margin help out the higher-rated tranches of subprime MBS.
In any event, I think it’s pretty clear at this point that Libor has reached the end of its useful life, especially when it comes to semi-fictional constructs like 3-month and 6-month Libor. When was the last time that any bank got any significant funding in the six-month interbank market? And it’s just plain silly, in a world where mortgages are securitized and sold off to non-bank investors, that repayment rates should be tied to interbank funding costs or any measure of financial-industry credit risk. Whatever happened to the Prime rate? That would be a much better benchmark.
(HT: Free Exchange)