LIBOR, the London InterBank Offered Rate, has been in the news lately as heads begin to roll in London and soon New York now that it’s clear LIBOR was manipulated by big banks, affecting the value of hundreds of trillions worth of financial instruments. This is a complex topic and it will be awhile — perhaps years — before it is clear how or even if you and I were damaged by these shenanigans, but everyone seems to agree that it can’t be allowed to happen again. But how? To make this happen I think we need a new understanding of what “transparency” means in financial transactions in the 21st century.
Transparency is supposed to mean that all parties in a financial transaction share the same information so nobody is blindsided. In practical terms transparency has usually meant something less: 1) that all parties can have the same information if they are willing to do the work to find it, and; 2) that all parties are held legally responsible as though they had the appropriate information. These latter statements mean generally that true transparency isn’t viewed as practical so all parties are on their honor to act transparently.
Yeah, right.
LIBOR, which is worked out on a daily basis through phone calls between banks, is anything but transparent, which is why Barclays and other banks were able to squeeze it in one direction or another. But that doesn’t mean LIBOR can’t be made transparent. In the Internet Age, in fact, I think this would be trivial to accomplish.
True transparency, real transparency, is for the first time ever well within practical reach. And therefore it should be demanded.
All that’s required to make setting LIBOR rates truly transparent is to direct all communication through a recorded channel. There are many of these but I’m most familiar with Yahoo Groups, where almost every day I share information with other owners of DA-2A aircraft.
If there was a Yahoo Group called LIBOR and it was declared the exclusive channel through which banks would communicate to set LIBOR rates, then it would preserve forever a minute-by-minute record of who said what to whom. Better still, that record would be accessible to banks, academics, and crackpots worldwide.
And while banks and academics occasionally collude, we crackpots never do, which is what makes us so valuable to society.
How do you prevent communications “off the record”?
You can’t, but you can criminalize is it. Won’t stop it completely, but a few bankers cooling their heels in prison may give others pause.
It certainly hasn’t so far. In China, they execute corrupt executives, and I haven’t seen even that make a difference.
Communism and corruption are nearly synonymous. Communists don’t execute corrupt executives, they execute executives that don’t adhere to the party’s ideology or alienate some powerful party member (or merely lose their support) by not providing the proper kickback or whatever.
Capitalism and corruption have always been more strongly linked and because we have done nothing about it, it continuous to get worse as recent events demonstrate. The trouble with executing those involved is that it involves formal processes and courts. It would be more of a deterrent if those responsible were subject to summary justice at the hands of the general public.
Seems the boiling-frog syndrome would still work, especially if enough banks colluded.
-Yahoo Groups, +Twitter
I can get alerts on my iPhone based on certain Tweets. There’s also a Twitter API that I’m sure would be useful for checks and balances.
I see one problem. We obviously can’t trust our newspapers and broadcast media to impartially report the news. How can we trust social media–a recent innovation with no tradition of integrity and transparency, and no legal responsibility to maintain the same–to safeguard the public interest? Especially a weakened shell like Yahoo, vulnerable to takeover and financial pressure? This is definitely one area in which government regulation is the only feasible solution.
I keep seeing this nonsense without a shred of proof. put up or shut up. unlike most nations’ media empires, we have a number of good neutral sites of record… New York Times, Christian Science Monitor as examples… as well as trumpets to the choirs, such as Fox News and MSNBC on opposite sides.
if you are railing against MSNBC or CNN, well, we know what side of the aisle you sit on.
if you whine against the Charlotte News-Observer or the CSM, I just don’t know if you’d be satisfied if we hung you with a NEW rope.
You can also look to Al Jazeera English. Good news about the US can come from outside of the US (although they have a great team in the US).
As others have pointed out, they would still be able communicate off the record by other means, so that idea won’t work.
What will work is to base the Libor rate only on real, publicly available transactions, not on guesses and offers. This is the way it is meant to be done, and it needs to be enforced.
Marcus Agius claimed today in his testimony before the Finance Committee that the problem was that at the height of the financial crisis banks weren’t lending to each other, and so there were often no real transactions to base the Libor rate on. They had to guess, and at the same time they had great incentives to lowball the rate.
That may have been true at that particular time, but it’s also clear that the rate was routinely manipulated for years both before and after the crisis.
What needs to be done is that only real transactions must be used for calculating Libor, and those real transactions need to be public – something that the banks don’t want.
BINGO! This is the right answer and quite feasible.
We may be able to come up with a proper *substitute* based on actual transactions — a good idea in my opinion.
LIBOR, however, is supposed to measure the interest rate for inter-bank lending between a handful of the largest institutions. These bank’s don’t borrow from each other every day, even if market conditions change significantly. For example, during the 2008 panic there were long stretches where zero interbank lending took place. Yet market conditions were shifting violently. Since we can have gaps in *actual* data, LIBOR is an *estimate* of the rate.
I’m not saying its good or bad, or that trillions in transactions should be based upon LIBOR; rather, something based *only on actual* transactions cannot be LIBOR.
The market has already solved this. Not the PR problem of the scandal (and everyone in finance has known that LIBOR was a fraudulent guess for many, many years; the inside joke just leaked out), but the idea of a benchmark rate for interest-rate-sensitive instruments.
GCF Repo satisfies all of the criteria:
1. It’s based on real transaction data — the DTCC/FICC.
2. It’s based on a relevant, healthy marketplace. Fed Funds and Time Deposits are shadows of their former selves due to the current interest rate and credit environment, with volumes down by 70-80% from 4 years ago. Repo, especially Treasury GCF Repo, has grown like crazy, and does about 150-200B in daily par value.
3. It has a futures market — just launched this last Monday on NYSE Liffe, with healthy volume (~3000 contracts per day).
4. It may become the rumored benchmark rate for the US Treasury’s upcoming floating rate notes, which would be game over.
These ideas about “Yahoo! Groups” are the delusions of someone with no sense of how finance (especially how the quirky insiders of finance) operates.
If the problem is solved by GCF Repo, then why is LIBOR used?
Human nature being what it is — there will always be corruption and self-serving bias in high places. As for trying to regulate these types of wrong doing, you have one set of thieves trying to police the actions of another set of thieves. This may work if the thieves being regulated are not as powerful as the regulators. But if not, there is no hope for honesty to triumph.
The most you could hope for to mitigate the problem is having independent watchdog groups (such as Cringely) to comment on the most egregious instances. Thanks for reporting this, Bob.
Well, I guess that would be _one_ way to keep Yahoo from going out of business…
The only reason banks have this kind of power is because of the trillions of dollars in debt we all owe. It sounds crazy and impractical, but if we all went to cash. eventually, there would be less debt to manipulate, who knows we might one day make more than .2% on our savings.
We were all duped, like lemmings we all dove off the debt cliff, and foolishly thought the banks would throw a life-preserver; obviously delusional since there is good interest to be made fooling more lemmings.
The only way to win, is to quit the game,
Banks can create virtually unlimited amounts of money out of thin air. But to pay back the loans that banks make to them, ordinary people have to work and produce something of value.
Bankers have had the sweetest scam ever conceived by the mind of mankind (or womankind).
The financial people have the second sweetest scam, IMHO. The sweetest scam was institutionalized 20 centuries ago. They use dogmas so you can not question or doubt anything and even have their own country…
Like always, just follow the money. It always flows in one direction – towards their city state…
Or how about you don’t allow ANY communication. Instead of basing LIBOR on what bankers quote for rates, base it on the ACTUAL lending rates they use in the transactions of the previous day or week or whatever. It’s easy to say “I’ll lend money at 3%” but then actually lend it at 3.2%. You can’t manipulate numbers on real money moving hands.
Stirring in the news in the UK is essentially that the Bank of England the Labour chancellor (who sets the financial policy) of the previous government did in fact know about the Libor setting, and were also active in fiddling it too.
Both deny this, so it must be true! 😉
Economies need a bench mark lending interest rate – but, it is not possible to have a transparent bench mark interest rate.
The “prime rate” that was quoted many years ago – but, no longer. The prime-rate is obviously a “made up” number changed at the whim of bankers to what ever they find convenient at any point in time.
Treasury rates had to be abandoned as a bench mark because the Fed obviously and officially modifies those rates to meet political objectives.
I really never understood why anyone thought that LIBOR was anything other than some random “made up” rate generated by banks to facilitate their economic aspirations.
The IRS posts interest rate bench-marks based on “investment grade” US corporate bonds. This works fairly well. US bond markets are notoriously corrupt and grade-A bonds are very corrupt – but, given a large selection using clearly pre-defined screenings the IRS bench-mark rates are very transparent and genuinely helpful for decision making purposes.
The problem that is currently arrising is that current investment grade US corporate bond rates are being indirectly impacted by the US Fed manipulation of the US Treasury interest rates.
Current long term yield of US corporate bonds is about 4.66% – but, no one actually thinks that is going to be the rate 20 years from now – even if that is what a 20-year corporate bond goes for today. Today’s rate is indirectly impacted by the Fed’s manipulation of the US Treasury rates. This is a very big problem. Everyone knows that 4.66% rate could pop-up to 7% in less than a day – and, probably will at some point in the future.
“it would preserve forever a minute-by-minute record of who said what to whom. ”
Or maybe not – Presidential Records Act mandates the preservation of all presidential records.The Bush White House simply used a RNC purging email system instead the White House system that woud preserve them forever.
Municipal bond bid-rigging done by Wall Street is no better than waste disposal bid-rigging by the mob:
http://m.rollingstone.com/?redirurl=/politics/news/the-scam-wall-street-learned-from-the-mafia-20120620
Where is J. Edgar Hoover?
Frontline’s fourth Wall Stret epesode (Money, Power and Wall Street) describes what Wall Street did in Europe:
http://video.pbs.org/video/2229573868
Australia’s Bank Bill Swap is “is the rate at which the banks are actually lending that morning, with a calculation done at 10.08am; with Libor it’s what the banks SAY they are lending at.” (https://www.businessspectator.com.au/bs.nsf/Article/RBA-interest-rates-Barclays-Diamond-Libor-central–pd20120704-VUT24?OpenDocument&src=sph)
It doesn’t stop all manipulation – as the article points out, such things are manipulated for particular reasons such a government policy – but it’s a much more transparent system.
DA-2A? I might have guessed it would be something like that. I’ll be at OSH next week-will look around for one. I’ve seen only pictures.
-Dave
There is a simple-enough solution. LIBOR implies the rate at which banks of certain credit “quality” lend money to each other. Instead of having banks indicate a # periodically which may have no bearing on where they are actually lending, require that inter-bank lending occur over an exchange and only on the exchange, on penalty of law.
LIBOR would then be the transaction-size weighted average rate of these transactions, dropping the high / low end outliers.
In the end, the best way to keep the # honest is to make sure that banks themselves must pay the reported interest rate in borrowing. A bank wants to have the lowest rates on its own borrowings, and hence will balance the rate, based on supply and demand.
I find it interesting that most comments seem to miss the underlying premise that real trades don’t exist upon which to base the LIBOR rate; that’s the reason for LIBOR in the first place. Even Bob recognizes and accepts this. His suggestion is to reduce collusion (of the self-serving undesirable type that’s not in the public interest) by ensuring all communications are open. However, as the posters have correctly pointed out, it may be hard to limit all communication to the approved channel. I don’t have the answer and neither does anyone else. So once again, Bob has made us think about the intractable problems of government, business, and life. Perhaps we need a culture based on an imaginary Entity that sees all and provides punishment for all eternity after death for any transgressions against the common good.
I don’t understand why people don’t look at the numbers more. Take the example in this post: any one bank can move its number at most 0.01% before I gets kicked out of the calculation. That 0.01% is then divided by 8 to contribute to the final number, making a difference of $12 per million per year. Ignore all the talk of trillions outstanding – most of it nets off in hedges. There’s no way anyone got rich on that kind of movement.
So far, one bank has been fined for /attempting/ to manipulate the rate. We know from the above calculation that either they achieved very little, or that a great many banks conspired to move the rate. And if that size of conspiracy exists, I doubt it makes any difference how the mechanism is /supposed/ to work.
First, ALL communication on a trading floor is recorded. This include phone, corporate cell phone, instant messaging from all approved providers. To avoid any confusion, anything not approved is blocked by the bank firewalls. Forgot Facebook or Twitter. Also, because it is hard to see if a cell phone is personal or corporate, it is forbidden to have it on the floor PERIOD.
The LIBOR rate is a complex mesure. It is the “current interest rate for AA banks”. So it can’t just be guessed from the price in the market but it is evaluated by the different banks INDIVIDUALLY and WITHOUT COMMUNICATION from the bank view of the market. In this case, traders involved were communicating where they should ensure strict separation.
To manipulate LIBOR you can’t just do it alone as you can see in the methodology. If you are too off, you leave the middle 8 and you don’t change the rate. You need to be IN the middle and be with others.
The real issue is not transparency : it is the education of the general public of how the system works. Who on “Main Street” knows what is LIBOR? What it is used for? And how it affects them? … I can tell you almost nobody!
http://en.wikipedia.org/wiki/Libor#Reliability_and_scandal :
“By July 4, 2012 the breadth of the scandal was evident and became the topic of analysis on news and financial programs that attempted to explain the importance of the scandal…On July 6, it was announced that the U.K. Serious Fraud Office had also opened a criminal investigation into the attempted manipulation of interest rates…”
I think the point is that something happened, even though unlikely based on the design of LIBOR.
[…] you know it’s time to move. Cringely wants guys to put their libor levels on Yahoo Groups, here. Sry, Libor submission guys past and present – you now are looking like the Galaxy Quest guy […]
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So has there been any update on this? The obvious thing to say about something like this is that at the end of the day, the average citizens will be the ones that will have to pay for this if it turns out to be true.
I find it interesting that the law actually encourages this type of behavior. First, it states that if you want all the information, you’ll need to work hard to get it. Secondly, if you didn’t work hard enough and didn’t find what you didn’t even know you were supposed to find, the law acts as if you DID know it, and therefore you’re not protected.
This just doesn’t smell right to me.