Economy Better, but Not Yet Out of Woods

On Wednesday, the three-month Libor rate was calculated at 2.76%. That's a significant premium to the fed funds rate target of 2%. It's also a large spread over the 1.68% yield on the three-month U.S. Treasury bill, which represents a rate that's free from the market's concerns about banks' financial health because it's backed by the U.S. government.

Recently, the spread between Libor and the yield on a three-month Treasury bill was 1.08 percentage points. That's a far cry from the 1.58 percentage-point spread in mid-April, suggesting that banks are becoming more comfortable lending to each other. That said, in the five years before the credit crisis began, the spread averaged a mere 0.28 percentage points.

"It's clear that there's still a huge amount of dislocation in the interbank lending market, and there's going to be a period of time before banks get truly comfortable lending to each other," says Daniel Alpert, a managing director with Westwood Capital. "Every bank is concerned about what's in other people's closets because they know what's in their closets."

To make matters worse, speculation is growing on Wall Street that Libor is artificially low. The rate comes from data compiled daily by the BBA that is supplied by banks all over the world. Observers suspect that banks may be unwilling to report their true cost of interbank borrowing for fear of revealing the full extent of their liquidity problems and becoming the next Bear StearnsBSC. The firm, crushed by rumors it was becoming insolvent, was bought by JPMorgan ChaseJPM for $2 a share in March, with aid from the Fed. JPMorgan later increased its offer to $10 a share.