E LIBOR Destroyed Subprime. But The Fed Deepened The Great Recession

But if you look at interbank lending in the third chart, it continued despite the high cost, even increasing in August and September, 2008 prior to Lehman! LIBOR cost increases in 2007 did not slow interbank lending down at all for the big banks between each other, until Lehman!

What really slowed with the LIBOR explosion in chart 2 was subprime to the public. According to Investopedia, the most common subprime loan was an ARM, which started out with a low fixed rate and then converted to a floating rate based on LIBOR plus a margin. When LIBOR rose, that margin was undone. That could explain why banks like Barclays were desperate for LIBOR to decline back below the Swap line.

So, Selgin, who may not view all this as part of a master plan, (you have to ask him), clearly catches Ben Bernanke in a strange statement that clearly is diversion from actual events. Again, the third chart clearly shows that the first vertical line, September 15th, 2008, Lehman's collapse, was the start of interbank lending collapse.

The second vertical line, October 15th, shows small banks beginning to receive interest on reserves. Small banks receiving IOR did not destroy interbank lending.

In fact, interbank lending did not fall off the cliff until the third vertical line, October 22, when the big banks began receiving interest on reserves! IOR for the TBTF banks was the main factor in the destruction of interbank lending.

But it is clear that the interbank lending decline, (chart 3) was not in the mirror of the LIBOR explosion timeline, chart 2, until the collapse of Lehman almost 2 years later. The explanation by Bernanke is factually incorrect. But it is true that toxic CDOs and CDSs based on subprime lending, destroyed by LIBOR's push upward, lead to Lehman's collapse. The destruction of interbank lending due to toxic subprime paper, exposed by Lehman's demise, was a delayed reaction.

Bernanke's Fed is almost rewriting history, it seems. But their own chart 3 refutes that "history". And if go to FRED, if you extend chart 3 back to 2006-2007 you will see that interbank lending was increasing in 2007.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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Joe Economy 5 years ago Member's comment

Its questionable whether the Fed's raising rates by 0.25% has had such a drastic effect on the economy. Other major factors combine together to make a recession. The overly strong dollar which hurts exports, the decline of oil, and the fall of China's economy and the knock on effect globally are likely more likely to blame. You never know, if things get bad, maybe Yellen will decide to reverse her decision and lower rates again. Stranger things have been known to happen!

Gary Anderson 5 years ago Author's comment

Rising rates would not be a problem if the Fed did other things to loosen.

Joe Economy 5 years ago Member's comment

Do you foresee the US following Japan and going negative on rates?

Gary Anderson 5 years ago Author's comment

It doesn't seem to concern the Fed if that happens. I will have a new article, hopefully, out on that today, Joe.