LIBOR Says Stress Building Up, Financial Crisis Could Be Ahead
Money is becoming difficult to get. Liquidity seems to be drying up and gone are the days of easy money. And this could all lead to the next financial crisis.
Before going into any details, let’s get a few definitions out of the way so there isn’t much confusion. “Liquidity” refers to ease of money in the financial system, while “financial crisis” refers to when there’s panic: when you have declining asset prices, investors hoarding cash, and maybe bank failures.
Like I said, it’s becoming difficult to get money. By that, I mean that if you want to borrow money, you are going to pay a heavy price for it. When this sort of scenario happens, a financial crisis could become reality sooner than later.
Remember what happened just before the financial crisis of 2008–2009? Lending dried up and there was a cash crunch; it was really difficult to borrow money. This resulted in bank failures, a stock market crash, and many more problems.
To give you some perspective, look at the chart of the London Interbank Offered Rate (LIBOR) below. Think of this rate as an interest rate at which banks loan to each other. The LIBOR rate is also a sort of stress indicator of the financial system, with a lot of debt tied to this rate.
If the LIBOR is soaring significantly, it suggests there’s stress building up.
Chart courtesy of StockCharts.com
In 2015, the LIBOR rate stood around 0.2%; now, it’s at 2.75%. That means that in just a matter of three years, the LIBOR rate has increased close to 1,300%.
The last time the LIBOR rate was this high, there was a financial crisis in the making. And it’s screaming that there’s stress in the financial system and another crisis could be looming.
But Wait…
Looking at the LIBOR, one might argue that this is happening because the Federal Reserve is raising rates and that there’s really nothing to worry about.
Hands down, one of the biggest reasons the LIBOR rate has increased is because the Fed is raising rates. However, the change in the LIBOR rate over the past three years has been way too quick.
The last time the LIBOR had this sort of move to the upside, it was between 2004 and 2006. Guess what was happening during this time. Liquidity was drying up and—yup, you guessed it—a major financial crisis was brewing.
Bringing Everything Together
It’s very evident that there’s stress building up in the financial sector.
If the Federal Reserve raises rates going forward, I believe it would be akin to throwing more gas on the fire.
I shall continue to watch the LIBOR rate very closely. If it soars, there’s a lot of money that’s backed by this interest rate, and it could be in trouble. And that’s on top of the other problems it could create.
As all this happens, I will also be watching big bank stocks closely—not just in the U.S., but globally. In case stress builds in the financial sector, big bank stocks could come down significantly.