LIBOR Indicates Credit Crisis Deepening As 2008 Draws To A Close

The rate at which banks lend to each other hit its highest level in two months last week, and may soon approach record levels established last year – an indication that the credit crisis is far from over.

The three-month dollar London interbank offered rate (LIBOR) last week reached 2.81% — a level not seen since June. The LIBOR is fixed on a daily basis by the British Bankers’ Association, which averages the daily borrowing rates of 16 different banks.

At 2.81% Libor was 81 basis points higher than the benchmark Federal Funds rate. The spread between the two key rates was just 24 basis points in January, but could be as high as 85 basis points by December, according to futures trading. The average spread between the two rates was just 12 basis points before the onset of the credit squeeze last year.

A difference between the rates as great as the one we’re seeing today suggests banks don’t trust, and subsequently, won’t lend to one another. Losses and writedowns stemming from the collapse of the housing market now exceed $504 billion at financial institutions, according to Bloomberg data. A drop-off in global economic growth and a growing number of credit defaults have compounded the risks already prevalent throughout the market, and may come to a head in the next few months.

Confidence in financial firms has steadily evaporated since the onslaught of the credit crisis a year ago. The collapse of The Bear Stearns Cos. Inc. and a possible bailout of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) were two of the major breakdowns to erode trust in the financial sector in the past 12 months.

“These problems going into year-end are likely to be worse this time round because of the amount banks have to refinance in December,” Resolution Investment Management Ltd.’s Stuart Thomson told Bloomberg, citing a figure of $88 billion. “The suspicion is that banks are still hiding losses. The banking system relies on trust and at the minute there quite simply isn’t any.”

Citigroup Inc. (C) analyst Prashant Bhatia recently widened his third-quarter loss estimate for Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), and Lehman Bros. Holdings Inc. (LEH). Bhatia expects Goldman to write down an additional $1.8 billion in securities and Morgan Stanley $1.7 billion.

Bhatia thinks Lehman will fair worst of all, writing down $2.9 billion. 

Meanwhile, Bank of America Securities analyst Michael Hecht said he expects large U.S. investment banks to face a “lackluster, low-visibility” environment through 2008, because of their “still-large” balance-sheet exposure to mortgages, Reuters reported.

Troubled-asset disclosures for U.S. brokers and asset managers totals $443 billion, down from $599 billion a quarter ago, Hecht said, adding that there was still quite a “hangover” to work through for the industry.

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