Wednesday, July 25, 2012

LIBOR 2.0: Is the Biggest Manipulation Yet to Come?

By Bob English

Is LIBORgate the crime of the century? Or is the real crime yet to come?  As has long been alleged at, the biggest manipulators of short term rates are the central bankers themselves.  Yet, they (unfortunately) have been ignored by the MSM in this mess--even the Bank of England, which appears to be directly culpable.  (See also this article from Business Insider, which reveals that the Fed itself already killed the LIBOR market long ago.)

Nevertheless, the central banksters,who never let a good [appropriately planned] crisis go to waste, apparently have an even more manipulated scheme to follow.  We discussed this today on RT's Capital Account with Lauren Lyster (link ), along with a diversion into the timing of the whole LIBOR scandal, which happily coincides with the potential court-ordered release of Eliot Spitzer emails that might publicly exonerate Hank Greenberg and AIG (don't worry, CNBC is already on board).  If there were ever a moment when Wall Street and DC diverged in recent memory, it is now.

Last week, Chairman Bernanke spoke off-the-cuff to the House in a Q&A session and mentioned three potential  alternatives to LIBOR.  It seems the global central bankers have already planned a September 9th meeting this year to discuss exactly that.  And, while details are sketchy at present, whatever replaces the benchmark--to which approximately $500 trillion in notional financial products are pegged--is guaranteed to have the most powerful of influences behind it.  

According to Bloomberg, this meeting, to be headed by Bank of England Governor Mervyn King, will be conducted [behind closed doors], only to be followed up by another [semi-secretive] meeting amongst the policy-makers at the international Financial Stability Board.  

To date, the only central bankers talking are Bernanke and his Canadian (Bank of Canada Governor) counterpart, Mark Carney.  Mr. Carney, echoing Mr. Bernanke, laughably said, "There is an attraction to moving toward obviously [sic] market based rates if possible," he said.  

Market based indeed.

Both Bernanke and Carney mentioned repos (repurchase contracts, presumably of Treasurys/T-Bills) and OIS (overnight indexed swap rates) as replacements, and a third addition by Mr. Bernanke is actual T-Bill rates.  Remarkably, there have been few discussions (though see this Stone & McCarthy report at ZH) of this game changing event--which could literally decide the fate of not only money markets themselves, but the life and death of the largest financial institutions (their living wills now cemented in the Eccles Building archives).  

The principal problem with using either T-Bill or repo rates (or any secured rate, for that matter) is that a premium must be charged.  So, who gets to determine the premium? (And, if some other concoction is devised that requires a discount, who determines the discount?)  Even if algorithmic in nature, someone must write the algorithm (just as some nameless face wrote the computer program supervised by NYU interns that has bought literally trillions of dollars in securities on behalf of the Federal Reserve).

The Fed's OIS Conundrum.  

If one delves into the OIS alternative, even more decidedly non-"market based" potential for manipulation exists.  First, OIS is a derivative rate based on an average of the Federal Funds rate--the rate the Fed prefers to manipulate to "target" short term interest rates.  However, the "Fed Funds" market is drastically different than years past since the Fed committed to near-ZIRP policy (since December 2008) and since having gained the ability (in October of 2008) to pay banks interest for the money they "keep out of the system" by parking it at the Fed (so-called Interest On Excess Reserves, or IOER).  

According to the Fed itself, the largest lenders/sellers of Fed Funds are the Federal Home Loan Banks and other GSEs (principally, Freddie and Fannie).  This is because, as non-deposit taking institutions, they are not eligible to earn the 0.25% interest the Fed pays to banks.  Instead, they earn income on their extra cash by lending it to banks, which, in turn, deposit it at the Fed to collect IOER.  Further, according to an email sent by a senior Fed economist to an EPJ reader, the GSEs prefer to lend only to a few banks (presumably JP Morgan, Goldman Sachs, and the usual suspects).  Here is the quote (emphasis ours):
Anecdotal evidence suggests that all of the housing-related entities are willing to lend to the same few banks, which limits the possibility for competition to raise market rates.
Thus, a LIBOR "alternative" that uses the OIS rate as its substitute switches from an average of declared rates by 14 or so banks to an average Fed Funds rate determined by back-door dealings between the largest government sponsored failures (GSFs?) in history and the compromised TBTF banks with whom they prefer to transact.  At least the Fed (and the administration) can sleep knowing this scheme limits competition to push rates to theupside.

None of this is to discount the fact that the large banks wantonly manipulated LIBOR for their own gain on a day to day basis.  Nor are we are not attempting to mitigate their culpability for such.  Were we given the chance to indict the banksters for LIBOR or for nothing at all, guess which we would choose (though, we'd insist throwing Corzine in for good measure).  

The point is that after all the show trials and show hearings on LIBOR, all we are guaranteed is that the central planning oligarchy will have its tentacles more firmly entrenched in its manipulation scheme of the entire finance sector.  The question is only which power centerswill be directing the circus.

Our Capital Account appearance begins approximately twelve minutes in (though don't miss the must-hear comments by Marc Faber regarding China and other matters)

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