Houston: We Have A Funding Crisis (And A Broken Libor Primer)

Tyler Durden's picture

As the ECB remains the liquidity provider of last and only resort, we suspect the oh-so-transparent central bank is causing some banks to avoid it and look to the cross-currency basis swap market to fund themselves in USD as the 3 month EUR-USD swap reaches 126bps (-6bps more today). These levels are the lowest (widest and most USD desperate) since December 2008 and perhaps, away from the SMP-driven sovereign spread markets, are the cleanest and least interfered with market view of the extraordinary USD funding crisis that is occurring. These stresses are just as evident in the GC repo markets and Goldman agrees with us that this crisis is escalating and offers a primer on why the GC repo / Libor markets are dysfunctional currently.

And in an effort to comprehend Libor's movements, Goldman Sachs takes a deeper dive into FF/Libor spreads and GC repo markets:

There has understandably been a heightened focus on funding and Libor over the past few months, but it's reached a crescendo in recent days as Europe has seemingly taken a turn for the worse. Globally we've seen FF/Libor begin to steadily move wider as funding pressures become more evident and market participants seek to hedge downside risks.




This is a finger-in-the-air exercise – particularly in an environment like this – but I think the US debt ceiling "scare" in early August provides a useful template / floor. Prior to August, money funds and other short end investors faced a massive collateral shortage and chased front end rates to near-zero levels. But once the debt ceiling debate really came to the forefront and investors sensed the potential for near-term bi-modal event risk, short end rates briefly spiked higher before the situation was eventually resolved.




On Monday July 25th, Investor XYZ was seemingly desperate for yield and comfortable lending cash overnight at ~5bps and in the return accepting collateral in the form of Agency MBS (essentially an overnight claim on the "effectively" government-guaranteed GSEs and itself collateralized with real estate). The following Monday, August 1st, that same repo exchange was trading at 40bps as Investor XYZ decided he would rather park cash in an FDIC-insured bank account earning zero rather than take overnight collateralized ultra-high-grade credit risk. (See the chart below for the levels of overnight GC for UST, Agency Debt, and Agency MBS repo during that period.)




When there's obvious event risk looming, investors – particularly those in the short end – have very little incentive to take this sort of bi-modal "headache" risk. In the example above, Investor XYZ was reluctant to lend cash on an overnight basis in exchange for agency collateral that is "effectively guaranteed" by the US government – 40bps may have been the effective breakeven clearing level. Conservative short end money is rightfully more concerned with the return OF capital rather than the return ON capital. So what does this mean for USD Libor?


3m Libor is supposed to represent some trimmed-mean average of where a panel of 19 global banks (11 of which are European) are able to borrow on an unsecured basis for three months, but in reality, only a handful of banks are actively raising cash for that term (mostly issuance from the likes of Aussie / Canadian / Scandi names who are underrepresented on the panel). Libor has for years been an "interesting" figure (I'm sure to get some strong comments on this), but it's probably especially so at the moment given the obviously large distinction between the "haves" and the "have nots" and the lack of overall data points in money market space.


So if only three months ago, Investor XYZ was afraid to lend ** overnight collateralized ** at 40bps, what's the likelihood that XYZ would be willing to lend ** uncollateralized 3-month term ** for anything even close to 40bps? As 2008 taught many of us, there's a clearing level for everything, but with Libor having set today at ~46.5bps, that 6.5bp extra "compensation" seems especially paltry. Granted, Libor is priced to increased to about 60bps over the next month, but even after reaching that level, will it be fair? A Belgium (AA+) bill auction this morning itself tailed by 60bps... 60bps.


I write the above knowing that many will respond and again remind me that Libor is only a survey-based number that may not always accurately represent universal funding reality; I can appreciate that. But I also write the above to point out that with the current volatility in the world, the "right" level for Libor is likely significantly higher than where it's currently setting and very likely where it's currently set to go. So the current drip-drop increase in Libor can probably go quite a bit further and pick up the pace if one assumes the volatility persists and if one assumes that Libor is very slowly converging to the "right" clearing level. Yes, the banking system as a whole has become better capitalized and has an improved liquidity profile, but in an environment punctuated by an overall questioning of previously risk-free sovereigns, this sort of systemic re-pricing shouldn't be unexpected.




Libor should in theory be capped given the outstanding FX swap lines that the Fed has in place with various central banks. Specifically, the Fed offers unlimited USD liquidity (up to 3m term) to foreign central banks at OIS+100 who then pass these funds to foreign banks. Currently, OIS+100bps equates to about 1.08%, but as central banks tend to only lend against haircutted collateral, the effective cost of funds will in practice be even higher. A colleague in Europe – Bernhard Rzymelka – did an analysis in September and found that this equated to a ~35bp charge at the ECB, so all in, the actual cost of funds via the FX swap facility may closer to the 1.40-1.50% vicinity. Hence, that should set the upper bound on libor. (Meanwhile, domestic banks – 3 of them on the Libor panel – are able to borrow collateralized from the Fed's discount window at 75bps.)




We see several different possibilities:


1/ Fed cuts the cost of the FX swap line to, say, OIS+50bps. The aforementioned "upper bound" would in theory then be reduced by the amount of the cut. While the effective cost of funding would still be near 1%, it would succeed in essentially cutting off a third of the negative tail of the distribution function (1.00-1.50%) and should do much to contain any further rise in Libor. That said, this option has been on the table for quite some time and the Fed has yet to go down this route, and in an environment where such an action would appear to be a "subsidy" to foreign banks, it would likely encounter some strong domestic resistance.


2/ Europe re-introduces bank debt guarantees. While the effect may be blunted given the obvious stress on sovereigns (the ultimate guarantors), this would on the margin make it easier for banks to obtain short-term funding.


3/ Fed cuts IOER. I'm sure I'll get pushback on this (people love to hate IOER), but if the Fed can push very short rates to zero or even negative levels, investors would likely feel more inclined to entertain the possibility of investing in short-term bank paper.


4/ Fed ends Operation Twist and switches to outright QE. As mentioned earlier, the front end of the curve has suffered from a dearth of collateral for months. By pledging to sell 400bn in <3yr securities, the Fed intends to quench a large portion of that thirst. Unfortunately, the Fed also succeeded in effectively "crowding out" other issuers in the front end. If the Fed isn't raising rates until mid-2013 and I can "risklessly" earn 22bps by buying UST 6/13s, I'm probably going to feel less inclined to buy much-riskier 3m bank paper at the current Libor set (~46.5bps). Thus, if the Fed were to curtail its selling of shorter-dated securities, I suspect short-term Treasury rates would crash lower and bank funding conditions may at the margin become easier.


5/ Europe fixes itself and tensions relax. In this instance, banks may feel less compelled to submit higher Libor sets even though their actual cost of funding may yet still be higher. But I think most investors would consider this outcome unlikely...

Chart: Bloomberg

(h/t David H)

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Hard1's picture

Funding Bitchez!  Every european bank has the MFer trade on, consisting on funding your FUCKING PIGS positions with the European Central Backstop (ECB).











Greece (again) and we hope this place is not taken by Germany



OK a couple countries there were a stretch, but no big difference in debt management between Nigeria an Greece.


scatterbrains's picture

What's the most active bank in Goldies dark pool market this morning ?

Hard1's picture

Oh, and the US banks have the same trade on. Only difference is that they did the synthetic version with CDS.  Guess who the counterparties on the CDS are!

CClarity's picture

And don't forget that oil is priced in US$ and one can always get US$ with gold too.  Watch what is happening in those two commodities for more clues on the pile in to US$ for the upcoming greater liquidity/funding/counterparty crisis.

SGS's picture

Yeah! All the momos running into the $US like lemmings! Yeah!

YesWeKahn's picture

C- Canada,

K- united Kingdom

N - Norway


Don't mess with African countries, they are the victims.

The Axe's picture

Ok...I need a tutor

idea_hamster's picture

I'll start and let everyone else jump all over me with corrections:

Euro-area banks that have USD-denominated liabilities are having a problem: they cannot get USD-denominated funding in the normal course of borrowing because no one is confident they will be around next week or tomorrow, and the ECB, their central bank, can't issue USD liquidity on its own.

There was a time when the ECB would use swap lines with the US Fed to act as intermediary for euro-area banks, but because everyone finds out who used ECB swap lines, the banks are reluctant to reveal how illiquid they are.

So the banks have gone to using cross-currency basis swaps, a floating rate interest swap contract, where (I presume) they would be paying out euro-denominated interest and receiving USD-denominated interest. This way, they get some USD liquidity through the private market.

Corrections, anyone?

Potemkin Village Idiot's picture

"Corrections, anyone?"

That's a pretty good thesis (green arrow up)...

I'll only add that in layman's terms its a 'clusterfuck surrounded by a circle jerk'...


idea_hamster's picture

If you hold your nose and look closely, you'll see that it's actually a gang rape surrounded by a anal-screw lap sit.

Oh, and that's us on the bottom.

LawsofPhysics's picture

"Oh, and that's us on the bottom."


Classic, any idea how much we will end up paying for this "lap dance".

Potemkin Village Idiot's picture

"any idea how much we will end up paying for this "lap dance"."

Historically, the more relevant question (rather than 'how much'), is 'out of which orifice' will be paying said amount...

idea_hamster's picture

To quote the old Lloyds wet marine partnership agreement, your're liable to "your last cufflink."

slewie the pi-rat's picture

or solve tyler's captcha:

(-6bps more today)

Potemkin Village Idiot's picture

kinky - the Bilderbergs must have invented that one...

I am more equal than others's picture

In other words, its a Penn State football camp with Coach Sandoski in the shower with Europe.

onebir's picture

"There was a time when the ECB would use swap lines with the US Fed to act as intermediary for euro-area banks, but because everyone finds out who used ECB swap lines, the banks are reluctant to reveal how illiquid they are."

Not sure about this bit. (Maybe I missed it?) It looks like the ability of the European central banks (aka ESCB) to cap overnight rates using US$ obtained via their Fed swap lines is limited by their current collateral policies + the Fed's current 1% OIS rate.

Today I learned:
GC = general collateral
OIS = overnight indexed swap

LawsofPhysics's picture

In layman's terms, what is this index supposed to represent?  Is it the ECB's available credit (in USD)?

HelluvaEngineer's picture

Opening bell...and all the morons run in to BTFD

SamAdams1234's picture

End game playing out.

prains's picture

Not such a cliff dive like last time but a more gradual desent into the abyss

Sancho Ponzi's picture

As manipulated as it is, the TED spread is getting ugly as well.


SheepDog-One's picture

I wouldnt count on such an easy ride...one of these mornings we'll be looking at an aircraft carrier sinking in the Straits, and ICBM contrails. I dont know what real good gold and silver and food and ammo will really do, but its better than nothing.

americanspirit's picture

Thank you SD1 - way too little focus on geopolitical issues here on ZH - until they hit the headlines that is. You are one of the best at bringing in that perspective. Let's try to get as far ahead of the geo-political curve as we ( collectively) are ahead of the fiscal/monetary event curve. I read a lot of geo-political blogs but have hesitated in the past to bring refs from them to ZH - maybe others feel the same. For my part I am going to begin trying to do some cross-linking.

Hmm...'s picture

sheepdog-one, I replied to you on the previous dead thread, but I'll repost here as it's topical to your post here too.

You said: How do you figure youre safe without food and weapons stored?

My reply:
I don't.  (and don't think I've ever said so, have I?)

I also don't think I'll be safe with food and weapons stored. 
And that is my point.

I've said this a few times before around here:  if/when the shit really hits the fan, it's going to hit the fan.  No matter how much we all prepare, almost everyone of us will be losers, and we will likely look back on these times with fondness, even though current times are totally fucked.  that's just how screwed almost everyone of us will be.

Thus: although I agree we need a global financial change, and I agree that we should try to protect ourselves as best as possible (PM, water, arable land, food, and yes, ammo), that is an entirely different than cheering the coming collapse or blithely thinking that I'll be ok just because I did those things.

Also: there is not one shred of data anywhere that would indicate that we as a species can survive a "quick crash" of a global financial bubble as large as we have, with so many nations armed to the teeth.  Depressions have a way of leading to World Wars you know.  The last one we dropped not one, but TWO atomic bombs on a country... one of them after they had all but surrendered.  You don't think we'll drop a few nukes?  Does anybody here think that their ammo will protect them from nuclear winter?

no, it is not me who underestimates the ferocity and the evil that lives in humans, nor what they will do to the innocent.

But perhaps I misunderstand the people who scream "Gold to $50,000/oz, bitchez" comments.  Maybe they aren't really cheering the collapse of the global financial system for personal profit.  It could likely just be them letting off steam knowing that we are all fucked.

Hmm...'s picture

ominous indeed.

Would people go long the dollar here, terrifying and foolish as that may appear?

If the stress is great enough I would think that players will sell anything and everything in order to get dollars.

ArkansasAngie's picture

It's amazing what people will sell when their electricity is about to be turned off for non-payment.  Insolvency is indeed a bitch.

And when they don't sell ... it's called involuentary bankruptcy.

Hey Benny ... QE 3 is not the answer.  Take your monetary debasement and stick up your nose.

SunnyD's picture

Can someone explain this to me? I get that lower numbers roughly equates to it's harder to fund in USD... but why? What the mechanics of these instruments that I should be aware of going forward? Thanks in advnace for the eplaination!

Potemkin Village Idiot's picture

The  'Triffin Paradox' is all you need to know...

foomer's picture

If i understand the chart correctly, it is the basis swap and is an indication of USD shortage.  Anything under -100 (cost of funding) indicates an illiquid market.  As you can see, it's at -125.  Someone with more knowledge of the credit markets could probably give you a better answer.

alien-IQ's picture

No lube. The sound of the people screaming in pain is arousing to TPTB.

rgilliam37's picture

Can the FED print and distribute privately?

If they can this shit will never end until it implodes under its own critical mass.

Paralympic Equity's picture

Well at -125 basis points the EU banks are screwed, because they pay more for USD than they get for EUR, taking into account that the ECB ref rate is now 1,25% not 1,5%...

Tic tock's picture

"the cleanest and least-interfered with.." is this sarcasm?

surf0766's picture

Everyone is waiting for the first guy to head to the door.

Potemkin Village Idiot's picture

It's too bad that 'the door' is a revolving one...

LawsofPhysics's picture

and by "everyone" you mean the trade bots, right?

SheepDog-One's picture

QE is a total failure....HEY I know! Lets do more of THAT! 

whirlybird rules's picture




and... straight t from the ECB Press Room..  I mean Reuters!  Note their pointing out that to date the ECB bond purcahses have been "modest" (?!)



alien-IQ's picture

Modest...like John Holmes at a bachelorette party.

alien-IQ's picture

nothing going on here that a juicy rumor can't fix.

expect them to start floating the rumors of bliss and happiness at about 11:35am

razorthin's picture

/sarc on

Ah but US Industrial production was better than expected.

/sarc off

americanspirit's picture

can you say "channel-stuffing in progress"?


PaperBear's picture

Gold/silver get whacked again and once QE is announced by BB to fill the funding gap, watch the hell out.

SheepDog-One's picture

I dont really believe it, PM's will be their main target to hold down until the wheels fly completely off...and then who will even care what the 'price' is? Also, theyre not going to do some diamond encrusted 'QE' just not going to happen.