Streetwise Professor

March 15, 2011

Lie-bor Lives!

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Regulation — The Professor @ 11:14 am

It is ironic that this story about UBS came out on the day I arrived in Switzerland.

UBS has received subpoenas from the SEC, the US Commodity Futures Trading Commission and the US Department of Justice in connection with investigations regarding submissions to the British Bankers’ Association, which sets LIBOR rates. UBS understands that the investigations focus on whether there were improper attempts by UBS, either acting on its own or together with others, to manipulate LIBOR rates at certain times. In addition, UBS has received an order to provide information to the Japan Financial Supervisory Agency concerning similar matters. UBS is conducting an internal review and is cooperating with the investigations.

I wrote several of posts about Lie-bor back before the financial crisis climaxed.  The story seemed to fade from view very quickly, despite the fact that the effects of a distortion in the LIBOR index due to misreporting could lead to the transfer of  Carl Sagan-esque billions and  billions of dollars between swap counterparties and floating rate borrowers and lenders.  Moreover, since unlike in the natural gas misreporting episode where some firms had an incentive to report prices that were too high (and did) and other firms had an incentive to report prices that were too low (and did), here all the potential misreporters had the same incentive: to underreport the rates at which they borrowed.  This would tend to cause the effects of misreporting to be greater, as misreports would have no tendency to cancel out.

I surmised at the time that despite the fact that there was some pretty convincing stories to support the claims, government regulators did not seem to pursue the allegations aggressively because (a) that was the least of the problems in the banking sector and regulators had other fish to fry, and (b) because of those other problems, regulators were beyond loath to compound them and pour additional burdens on banks that were already reeling and threatened to bring down the financial system.  Regulators were looking to put out fires, not start them.  LIBOR was something that regulators, like Scarlet O’Hara, could worry about . . . tomorrow.

Those days of forebearance, it appears, are gone.  If you are a there’s-got-to-be-a-pony-in-there-somewhere kind of person, you might view this investigation as a strong signal that regulators believe that banks are healthy enough to stand the strain–and the potential fines (and perhaps damages in private litigation).  If you’re not, you’re probably saying “when will it all end?”  Be careful what you ask for.

A gratuitous image of a UBS branch, a block from my hotel:

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  1. There is a movement within banks to move away from Libor as funding source and use overnight indexed swap rates instead (atleast for internal calculations 🙂 )
    A similar effect was observed in Japan in the nineties (perhaps even now) and that is the basis spread between Japanese libor and usd libor.

    Comment by Surya — March 15, 2011 @ 5:08 pm

  2. […] An article on the distortion of LIBOR rates.  LIBOR has huge implications in the swap market.  It is also the basis for the bulk of the trading done in Eurodollars on the $CME. […]

    Pingback by Interesting Links Points and Figures — March 16, 2011 @ 4:54 am

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