Volume 1, Number 1 • Fall 2008
HRPDC
Economics Staff
Greg G. Grootendorst
Chief Economist
James A. Clary
Economist
the hampton Roads
economic QuaRteRly
Paul D. Fraim, Chair • Dwight L. Farmer, Executive Director/Secretary • John M. Carlock, Deputy Executive Director
Spread Between 3-Month LIBOR and Effective Fed Funds Rate
Basis Points-50
0
50
100
150
200
250
’07
’08
JanFebMarAprMayJunJulAugSepOctNovDecJanFebMarAprMayJunJulAugSepSource: British Bankers Association, Federal Reserve
The London Interbank Offered Rate (LIBOR) measures the interest rate that banks offer to lend unsecured
funds to one another. The Effective Fed Funds Rate is the cost of overnight lending from one bank to
another, but is often near the target established by the Federal Reserve. The difference between the two
rates (the spread) is the clearest indication of perceived default risk in the financial markets.
The Frozen Credit Market
The worldwide credit markets have been seizing up gradually over the past eighteen months,
but the situation has become increasingly worse since the bankruptcy of Lehman Brothers.
As financial institutions have been unable to borrow from one another, many have been
forced to undergo reorganizations and takeovers as demands on previously authorized lines
of credit and runs on deposits have left these banks significantly under capitalized. President
Bush recently signed a $700 billion rescue plan into law, but there remains significant
confusion as to the relationship between the financial markets and the local economy.
Financial institutions entered the crisis because they were highly leveraged and a large portion
of their capital comes from the housing market, which is currently undergoing a national
correction. The correction would have put stress on a well capitalized financial system, but
as a result of new investment vehicles, many national banks were exposed to the real estate
market to an even greater extent than they were historically. Mortgage Backed Securities
(MBS) allowed a bank to