Streetwise Professor

July 19, 2012

LIBOR: Looking Forward, Looking Back

A couple of LIBOR-related items.

1. Timmy! claims that he and the FRBNY were “very forceful from the beginning” in dealing with LIBOR manipulation.  This is an example of why Timmy! (AKA Rodney Dangerfield) gets no respect.  His letter to the BOE was a classic example of bureaucratic CYA and buck passing: the BOE then exchanged the buck and passed the pound to the BBA which did . . . nothing.  More nothing happened for over three years, and it wasn’t the FRBNY that drove the process.  The scary thought is that is what passes for forceful in Timmy!’s world: the scary alternative is that Geithner is just BSing about his past forcefulness.  The thought that Geithner’s 2008 actions were forceful is Pythonesque, really:

Cardinal Ximinez: Cardinal Fang! Fetch… the Comfy Chair!
Cardinal Fang: [horrified] The Comfy Chair?
[Fang scuttles off, then returns with the Comfy Chair and sits the old lady down in it]
Cardinal Ximinez: Now, you will sit in this chair until lunchtime, with nothing but a cup of coffee at 11!

2. Central bankers are looking for an alternative to LIBOR, EURIBOR, etc

Central banks are exploring whether financial markets might be steered to adopting benchmarks other than Libor. Mr. Bernanke suggested a few alternatives at his hearings this week. Among them: The rate that financial institutions charge each other for short-term loans in “repo” markets in which they use their large securities portfolios as collateral for short-term loans. He said derivatives markets also provide alternatives, such as “overnight index swap,” or OIS, rates, which track central bank lending benchmarks.

That’s great going forward, but what about the $800 trillion or so in notional and/or principal amount of outstanding derivatives, loans, and other financial instruments with payments tied to LIBOR and its European and Asian cousins?  That would be a helluva lot of contracts to orphan.

LIBOR needs to be fixed, because of this massive amount of legacy contracts.  But how?  It won’t be easy, since the transactions that LIBOR et al should be related to-unsecured interbank transactions-aren’t orphaned: they’re damned near extinct.  Any decree by regulators that henceforth LIBOR should be something different than the creature that existed at the time these contracts, loans, etc., were created would potentially result in the shift of many billions of dollars of wealth, and spawn intense legal challenges.  (Ironically, any fines or damages arising from LIBOR manipulation-related legal actions will weaken banks and make the return of unsecured lending all the more remote a prospect.)

Looking for a replacement going forward is the easy problem: market participants have an incentive to come up with something more robust, there will be experimentation and competition, and perhaps with a little regulatory shepherding, in not too long something better (no doubt some sort of secured rate) will emerge as the benchmark.  Going forward, market participants can find transactions and benchmarks that are mutually beneficial.  That provides an incentive to get it right.

Finding a way to deal with the legacy of the past is going to be a much, much more difficult problem.  The primary effects of changes will be redistributive, rather than creative.  This will give rise to massive rent seeking and legal conflict.  Much fun will be had by all.  Especially the lawyers.

Print Friendly, PDF & Email


  1. […] But Tim Geithner was serious about Libor manipulation. He fetched the comfy chair and […]

    Pingback by FT Alphaville » Further reading — July 20, 2012 @ 1:42 am

  2. […] LIBOR: Looking Forward, Looking Back Streetwise […]

    Pingback by Links 7/20/12 « naked capitalism — July 20, 2012 @ 3:29 am

  3. Actually finding a benchmark not subject to direct manipulation may not be so easy. One of the ones touted has been the treasry repo rate_ there are lots of transactions that can be reproted through the Fed, etc. The only problem with this is that a lot of the volume is in the on-the-run coupon(s). A short on the desks can easily puch these rates negative, or at least did so when I was active and Fed funds were at 5%. I doubt things have improved.

    the key is to have the rqtes set by someone who deos not directly benefit -teh Treasury CMT comes to mind. Unfortunately those who do this are often political or work for poflitical types – think TruboTax Timmy atthe NY FED. Oh well.

    Comment by Sotos — July 20, 2012 @ 8:33 am

  4. @Sotos. Yes. There have been many repo squeezes. These tend to be issue-specific: particular issues go on special when they are squeezed. GC may be less susceptible; the issue is whether there is sufficient volume in GC.

    The ProfessorComment by The Professor — July 20, 2012 @ 8:57 am

  5. Go, Prof!

    I would be very surprised if one of the exchanges wasn’t already drafting a futures contract on Libor, with the deliverable being title to an unsecured interbank loan. Maybe a cash-settled futures contract that settles on actual loans made in that market. Proof of a real at-risk transaction could include the interbank confirms (on the buy side and the sell side … maybe settling against a volume-weighted average of such bona fide interbank loans on a particular settlement date … end-of-month, mid-month?), which would allow a real audit trail to be created (and presented as evidence in the case of fraud). It also would address the volume/squeeze concerns.

    One wonders if it is possible to arb such a contract against the eurodollar and treasury futures.

    Comment by markets.aurelius — July 20, 2012 @ 11:16 am

  6. Re LIBOR futures – cheapest to deliver = biggest lie? the mind boggles!

    Comment by Sotos — July 20, 2012 @ 12:23 pm

  7. When I was doing international borrowing doc there was ALWAYS a clause to cover the situation that LIBOR ceased to be quoted or was otherwise not available. So maybe it is not that big a problem – if it is lawyers have been negligent.

    Comment by Machaggis — July 20, 2012 @ 6:37 pm

  8. Oh, the games our Princes Play! When the crowds asked, Where’s the bread? Answered “Eat Cake”!
    Need Heads on the Pikes; Dimon, Blankfein, Mazzelli, Geithner,etc etc etc.
    Pikes on Wall Street,signed “he demanded austerity for the people after bankrupting the economy”.

    $800 Trillion, hell we are talking about real dollars?

    Comment by Jose 83 — July 21, 2012 @ 10:31 am

RSS feed for comments on this post. TrackBack URI

Leave a comment

Powered by WordPress