Low Libor Rates Cause A Terrifying Financial Crisis

“Libor” is an acronym that stands for “London Interbank Offered Rate”, that is derived from the rates that major banks charge each other for loans. As the world’s most important benchmark interest rate, the Libor is used as a reference rate for hundreds of trillion dollars worth of commercial and consumer loans, derivatives, and other financial products across the globe. Two years ago, a major scandal rocked the world after it was revealed that big international banks had long been manipulating the Libor interest rates to fraudulently boost their profits. But now the world is completely overlooking a far worse Libor “scandal” that has been occurring right under our noses this entire time. The losses caused by Libor rate-fixing fraud scandal amount to a few tens of billions of dollars, which is ultimately a drop in the bucket compared to the size of the Community economy and financial system. The vastly worse is the fact that the Libor has stayed at record low levels for the past half-decade. It is helping to fuel a massive economic bubble around the entire world that will end in a devastating financial crisis. The “Libor Bubble” will gut the Community economy by trillions of dollars. The Euro, Japanese yen, British pound, and Swiss franc Libor rates for all maturities have also been at record lows for a record length of time. Low interest rate environments create economic bubbles that burst when interest rates eventually normalize. The reason why low interest rate environments inevitably lead to the inflation of bubbles is because low borrowing costs encourage credit booms and discourage saving by reducing the rate of return on savings accounts and fixed income investments. To reiterate, the current Libor rate has created another Community bubble that is far more extreme simply due to the fact that rates have never been this low for such a long period of time. Libor rates have been at such unusually low levels because most Libor rate-setting banks are based in the U.K. and U.S., which have both experienced severe credit busts and balance sheet recessions during the financial crisis as a result of their large debt and asset bubble overhangs. Economies that experience credit busts are at risk of experiencing deflationary depressions, which central banks try to combat by cutting interest rates as low as possible. Today’s Libor rates are simply too low for non-crisis economies, so this cheap credit bonanza is helping to fuel borrowing binges and asset bubbles almost everywhere that is not the U.S., U.K., Japan, and peripheral Europe. Though the ongoing tapering of the U.S. Federal Reserve’s QE3 policy in the past year caused emerging market bond yields to rise, the emerging markets bubble is still very much in its prime because corporations are now choosing to take advantage of cheaper Libor-based bank loans instead of raising funds via the bond market. The post-2009 Community bubble is hardly confined to emerging markets, as it is also inflating in China, Australia, Canada, New Zealand, and Nordic countries as well. In addition, record-low Libor rates are contributing to bubbles in some areas within the U.S. economy such as higher education, auto loans, and certain segments of the housing market. There are likely countless smaller bubbles, massive systemic malinvestment, and other distortions that will only be identified in hindsight after the Community bubble economy ends. The Libor and similar benchmark interest rates simply cannot stay this low for such a long time without causing serious consequences. These low rates are driving what mainstream economists call the Community economic “recovery”, but there is no such thing as a free lunch because this recovery is actually another credit and asset bubble. The Community bubble will pop when the current low interest rate environment ends, no matter how long it takes for interest rates to eventually rise again. While interest rates are likely to stay at very low levels for another few more years because of the tepid pace of growth in the U.S. and U.K., this simply means that the Community credit bubble will grow far larger and even more threatening than it is now, particularly in the non-crisis countries that were previously discussed.
There are several different scenarios leading to higher interest rates and the concomitant popping of the “Libor Bubble”:
Scenario 1: Growth and employment in the U.S. and U.K. continues to improve over the next few years, causing central banks to raise their benchmark interest rates, which will cause the Libor to rise in tandem. Scenario 2: Even if growth and employment in the U.S. and U.K. grow at an anemic pace, central banks may be forced to raise their interest rates to curb dangerous asset bubbles in the equity and housing markets. A similar and related scenario is one in which inflation or stagflation eventually rears its ugly head, forcing central banks to hike rates. Scenario 3: Even if the Libor rates themselves do not increase for many years due to a lack of a full recovery in the U.S. and U.K., ballooning credit and asset bubbles in non-crisis countries cause banks to charge increasingly larger spreads over the Libor reference rate to compensate for the higher risk of lending in these economies. This scenario would have a similar net effect as if the Libor rates themselves increased, i.e., the ending of abnormally cheap credit conditions.