Thursday, July 5, 2012

LIBOR Scandal Nonsense

You know something is wrong with focus on the LIBOR "scandal", when Eliot Spitzer and Matt Taibbi think its the biggest scandal in banking. WaPo has an explanation of the "scandal" here.

Here is Spitzer and Taibbi having an orgasm about the scandal.



What's wrong with this take:

There is no way in hell that banks can "set" interest rates. Interest rates are market prices. If banks got together and claimed to be paying less than they were, which resulted in lower rates overall, this would result in a situation where the demand for loans would be greater than the supply. If banks claimed they were paying more than they were, then the demand for loans would be less than the supply.

Can banks attempt to game the system against other banks? Sure. Traders try to do this every day in all kinds of markets.

Here's WaPo on what Barclay's did:
First, from 2005 and 2007, the bank allegedly varied the rates it reported to the BBA and Thomson Reuters so as to improve its margins on internal trades. For example, it could have placed bets that the LIBOR rate would increase, and then reported artificially high rates which in turn artificially increased the LIBOR averages, so that the bets were likelier to pay off. This not only screwed the investors on the other side of the trade, but bumped up mortgage rates – however infinitesimally – for consumers even when the risk of the loans hadn’t changed at all...Second, in late 2008 Barclay’s – and, Diamond alleges, other banks – apparently low-balled the rates they reported for LIBOR averaging so as to make the banks’ finances look more stable than they were. The idea was to put out a false image of stability to prevent market panic and stave off calls for additional regulation or even nationalization, a solution that looked increasingly likely during the height of the financial crisis. The direct effect for consumers here was to make loans cheaper, but the indirect effect, or the intended one at least, was to lessen chances of government action against the banks

Note the "however infinitesimally", infinitesimal is correct. If Barclay's attempted anything else, it would have  resulted in distorted markets. Which means other banks, who used LIBOR as a base rate from which to charge more, would have just simply adjusted their premiums downward off of LIBOR, or simply ditched LIBOR itself. The fact that LIBOR is used by most banks as a base rate suggests that it has proven overall to be a pretty damn good tool to judge supply and demand for loans. Again, if it wasn't, it would have distorted the supply and demand for loans around the world.

Bottom line: This "scandal" is not very important. If anything, the fact that it was executed after 2008 to provide an indication of lower rates, to keep governments off the back of banks, suggests how expensive government regulations are that banks would indicate lower rates rather than have to deal with government. (Again, to the degree that the LIBOR rate in this case resulted in a distorted market, other banks who used LIBOR as a base would simply adjust the premium that was charged over LIBOR, BUT that banks use LIBOR seems to be an indication that they are pretty happy with LIBOR as a base indication of true supply and demand for loans, or they wouldn't use it in the first place.)

Of course, while all this nonsense about Braclay's and LIBOR grabs the headlines (especially in Europe), it should be noted that there is little discussion of real interest rate manipulators, central banks,  which can print money that really distorts interest rates and the economy and creates the business cycle and price inflation. That's the real scandal.

(video via Jaison De Montalegre)

14 comments:

  1. I thought the whole point of the LIBOR scandal was the governmental collusion and not merely the banks behaving badly. Rather it is banks covering for politicians by obfuscating the rates for government debt payments.

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  2. Couldn't you make the same argument about central banks setting interest rates, that it doesn't matter because the market will just adjust for it?

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    1. You could if the Fed simply said they were making the interest rate x without actually taking action to accomplish that. But since they control the printing presses and use it to control interests rates, no, you can't make the same argument about central banks. Unless you just mean that their attempts to set the interest rate will inevitably fail because a bust will eventually come from their manipulation.

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  3. No kidding. They are complaining about infinitesimal changes in interest rates created by Barclays while ignoring central banks who actually create major distortions to interests and the entire economy. People who get their info from the MSM are so lost in the weeds right now.

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  4. Because of leverage, though, these "infinitesimal" changes actually matter a great deal...it's just like in currency trading, small changes cause huge swings in levered holdings...

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    1. Huge leverage positions are banksters playing against each other. They do this in every market and it has almost nothing to do with a guy paying his mortgage. Unlike the massive interest rate manipulations done by the Fed and other central banks.

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    2. Obviously the Fed distorts LIBOR more than anyone (and it looks like the Bank of England asked Barclays to commit fraud in reporting their interbank rates, wouldn't be surprised if Bernanke asked GS et al to do the same)

      But, are you saying it doesn't matter because the changes are so small, and pale in comparison with the Fed's ability to create huge shifts?

      If the banks are lying about their interbank rates, it's still fraud, and like high frequency trading or the muni bond rigging scheme, another example of our parasitical financial engineers skimming capital from productive sectors of the economy.

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    3. Good points, Josh, but I do not think that RW is saying that it's not an issue -- just not as big of an issue as Taibbi and Spitzer claim.

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    4. I wonder how many muppets were shorted with advance knowledge of libor rate manipulation.

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  5. I've read this post several times today and can't understand the point you're trying to make. Cynicism of something that Taibbi and Spitzer are talking about? Fine. But the arguments presented here make a major jump in logic.

    "Note the "however infinitesimally", infinitesimal is correct. If Barclay's attempted anything else, it would have resulted in distorted markets. Which means other banks, who used LIBOR as a base rate from which to charge more, would have just simply adjusted their premiums downward off of LIBOR, or simply ditched LIBOR itself. The fact that LIBOR is used by most banks as a base rate suggests that it has proven overall to be a pretty damn good tool to judge supply and demand for loans. Again, if it wasn't, it would have distorted the supply and demand for loans around the world."

    So Barclays couldn't have been under-reporting their borrowing costs because to do so would have caused market distortions. And because banks use LIBOR as a rate for benchmarking other rates, they feel it credibility and reliably tracks what they believe is the rate of interest. Otherwise the market would be distorted.

    This is a circular argument.

    How about this: the market has been distorted for years because of various factors. We know that an asset bubble during this decade occurred because of the mispricing of risk and the artificially low interest rates. What's more is that main vehicle by which banks maintaining funding used to be set by interbank borrowing. That borrowing noticeably froze in 2008. The US Federal Reserve took it upon itself to "save" the banks by lending to them when a market would not clear. Since then, banks have borrowed billions directly from the Fed and rarely use the overnight interbank lending markets for liquidity. The LIBOR rate and the Federal Fund TARGET Rate are effectively irrelevant.

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    1. "So Barclays couldn't have been under-reporting their borrowing costs because to do so would have caused market distortions. And because banks use LIBOR as a rate for benchmarking other rates, they feel it credibility and reliably tracks what they believe is the rate of interest. Otherwise the market would be distorted.

      This is a circular argument. "

      No, he is arguing that if the banks thought this severely distorted the borrowing costs market that they'd not rely on this rate.

      Barclays had a very high rate of submissions relative to its competitors, which it believed should've upped their frequency. Irrespective of whether or not this is true, Bob Diamond and the bank are being used as scapegoats for public ire against the banks. It's funny, because Barclays is one of the few banks that didn't require a bailout, so perhaps it is malice on part of the government. The UK govt is utterly dependent on its financial sector to keep its ridiculously overrated junk debt at a low borrowing cost. If the BoE was complicit in this (not that it'd surprise me at all), the argument is all the more vacuous.

      Meanwhile... how much have RBS and Northern Rock cost the British taxpayer? How much does the BoE cost them? THis may be fraud but lets not lose track of the biggest fraudsters out there. Barclays is acting within the institutional setup the government has generated.

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  6. >Bottom line: This "scandal" is not very important.

    Disagree, it is like the Drip-Drip-Drip of excess Acid, the more perceived scandal going on in the banking system, the better. Maybe it finally spreads to the Fed, other Central Banks, and finally the politicians-those making out like bandits from it all
    are focused in on by 'the commoners.'

    LIEbor-LIEbor-LIEbor!!!

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    1. I agree totally. Never let a banking scandal go to waste. It's just another opportunity to show that the business model is fraud under fractional reserve banking. The kicker to people is that the fraud is legal. Though Barclays may have been misreporting their rates to the BBA, the BBA is a organization set up by the banks for the banks. The only reason the UK government is investigating them is that they lied to the regulator. And to statists, lying to them is a mortal sin.

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    2. Except when the regulator encourages the lies so that they can report glowing figures to their senior overseers. This tends to be what the farce of "independent" watchdogs entails, as is the case with the FOS in the UK (an "independent" watchdog that parasitally lives off fining the banks just for having a complaint referred to it.)

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