This is a particularly timely article. In essence, banks are raising the alarm that the LIBOR rates might be 'fixed' by large global banks providing false information. The banks are concerned because as a widely followed interest rate benchmark, LIBOR affects a signficant amount of financial activity in the real economy. And its bad for the banks' business, which is why it made the front pages of the WSJ and several leading economic blogs.
Categorize this under the title "Lack of Genuine Price Discovery in Manipulated Markets Leads to a Moral Hazard and Economic Distortion in the Real Economy."
The tricksters at Enron were able to manipulate the market for energy prices to the extent that they almost brought down the state of California, which is the size of most countries. Were the markets reformed? No, let's just move on.
The government has been manipulating key interest rate benchmarks pretty brazenly for years, such as CPI, through some of the most tortured and ridiculous of rationales imaginable. Some might say that this stealing from pensioners sets a rather poor example for the rest of the financial marketplace.
Just this morning the action in the S&P500 futures market was comparable to water running uphill. A recent ex-Treasury Secretary maintained its easier to fix "the problem" by manipulating the futures markets than cleaning it up afterwards. Not only was this NOT condemned, it was embraced by many academic financial types as clever and practical and cool.
Apparently some financial thinkers failed to learn the basic lessons of the schoolyard such as honesty and reputation and trust, because they were obviously hiding in the cloakrooms or library most of the time. Once you cheat or steal or lie, 'just this one time,' you often start doing it more and more for convenience until you do it all the time as a reflex. You parse the world into clever boys like yourself and stupid honest fools to be cheated. You become known as a cheat and a thief and a liar, and you hit the wall and fall from grace, and find yourself on the bottom.
(To the ex-Treasury Secretary's credit he did not use the word "manipulate," he used a more palatable euphemism which we cannot recall. But he is also not alone. Can you believe that there are some financial thinkers who maintain that by controlling the prices of key commodities and benchmarks the government can actually mask the impact of their reckless money printing? They call it 'managing the perception of inflation.' Take all this behaviour and put it on the schoolgrounds. What do you think about these boys now? Amoral little monsters. Yikes! - Jesse)
When the government gives a 'wink and a nod' to market manipulation, and either turns a blind eye and fails to prosecute, or bails out the miscreants using public money when they stumble and fall, or provides wristslaps without admitting guilt to the offending corporations when they get caught red-handed engaging in obviously illegal acts in the markets----
THAT IS MORAL HAZARD you fatheaded prunes.
There has been a lot of fuzzy thinking lately from economists who somehow have taken the posture that financial utilitarianism is the 'scientific approach' and that whatever 'fixes the problem' most quickly and cleanly is the optimum economic approach. Well, you might be able to build a career out of cheating, beating the system, invoking private privilege, and fundamental amoral lowness, but its a rough way to try and approach the problem of creating a sustainable, productive economy. It always and everywhere results in some form of totalitarianism.
"The President's Secret Working Group on Financial Markets" indeed. Future generations will think we were simply hypocrites or mad or deluded or all of it. Let's make reality a certain way by merely saying and acting as though it is.
What these fellows don't realize is that economic decisions almost always rest on the assumption of a moral judgement. There is no escaping it. It is better to cheat and break the rules one way and punish this group (usually of weaker innocents), than to hold some other more powerful group to account.
One has to do certain things when one is in a position of power. No, it when one is under stress in a position of power that they hold their whole selves in their hands, and their character is tested, and if they let go, they are lost.
Well, this is where that sort of thinking has brought us. We urge all economic students to take note of the slippery slope of moral retardation for the sake of expediency, and to start preparing now for the new wave of economic thinking that will come out of this period of economic vacuousness and lifeless neo-liberal madness.
Oh, and when this whole rats nest of dishonesty blows up in our faces, don't say you haven't been warned.
LIBOR FOG
Bankers Cast Doubt On Key Rate Amid Crisis
By CARRICK MOLLENKAMP
April 16, 2008
The Wall Street Journal
LONDON -- One of the most important barometers of the world's financial health could be sending false signals.
In a development that has implications for borrowers everywhere, from Russian oil producers to homeowners in Detroit, bankers and traders are expressing concerns that the London inter-bank offered rate, known as Libor, is becoming unreliable.
Libor plays a crucial role in the global financial system. Calculated every morning in London from information supplied by banks all over the world, it's a measure of the average interest rate at which banks make short-term loans to one another. Libor provides a key indicator of their health, rising when banks are in trouble. Its influence extends far beyond banking: The interest rates on trillions of dollars in corporate debt, home mortgages and financial contracts reset according to Libor.
In recent months, the financial crisis sparked by subprime-mortgage problems has jolted banks and sent Libor sharply upward. The growing suspicions about Libor's veracity suggest that banks' troubles could be worse than they're willing to admit.
The concern: Some banks don't want to report the high rates they're paying for short-term loans because they don't want to tip off the market that they're desperate for cash. The Libor system depends on banks to tell the truth about their borrowing rates. Fibbing by banks could mean that millions of borrowers around the world are paying artificially low rates on their loans. That's good for borrowers, but could be very bad for the banks and other financial institutions that lend to them.
True Borrowing Costs
No specific evidence has emerged that banks have provided false information about borrowing rates, and it's possible that declines in lending volumes are making some Libor averages less reliable. But bankers and other market participants have quietly expressed concerns to the British Bankers' Association, which oversees Libor, about whether banks are reporting rates that reflect their true borrowing costs, according to a person familiar with the matter and to government documents. The BBA is now investigating to identify potential problems, the person says.
Questions about Libor were raised as far back as November, at a Bank of England meeting in which United Kingdom banks, the firms that process bank trades and central bank officials discussed the recent financial turmoil. According to minutes of the meeting, "several group members thought that Libor fixings had been lower than actual traded interbank rates through the period of stress." In a recent report, two economists at the Bank for International Settlements, a sort of central bank for central bankers, also expressed concerns that banks might report inaccurate rate quotes.
ARMA spokesman for the BBA, John Ewan, said the trade group is monitoring the situation. "We want to ensure that our rates are as accurate as possible, so we are closely watching the rates banks contribute," Mr. Ewan said. "If it is deemed necessary, we will take action to preserve the reputation and standing in the market of our rates." Libor is expected to be on the agenda of a bankers' association board meeting on Wednesday.
In a recent research report on potential problems with Libor, Scott Peng, an interest-rate strategist at Citigroup Inc. in New York, wrote that "the long-term psychological and economic impacts this could have on the financial market are incalculable." Mr. Peng estimates that if banks provided accurate data about their borrowing costs, three-month Libor would be higher by as much as 0.3 percentage points.
A small increase in Libor can make a big difference for borrowers. For example, an extra 0.3 percentage points would add about $100 to the monthly payment on a $500,000 adjustable-rate mortgage, or $300,000 in annual interest costs for a company with $100 million in floating-rate debt. On Tuesday, the Libor rate for three-month dollar loans stood at 2.716%.
Libor has become such a fixture in credit markets that many people trust it implicitly. Concerns about its reliability are "actually kind of frightening if you really sit and think about it," says Chris Freemott, a Naperville, Ill., mortgage banker who depends on Libor to tell him how much his firm, All America Mortgage Corp., owes First Tennessee bank for a credit line that he uses to make loans.
The Libor system was developed in the 1980s. Banks were looking for a benchmark that would allow them to set rates on syndicated debt -- corporate loans that typically carry interest rates that adjust according to prevailing short-term rates. By pegging lending rates to Libor, which is supposed to represent the rate banks charge each other for loans, banks sought to guarantee that the interest rates their clients pay never fall too far below their own cost of borrowing.
Banks typically set their lending rates at a certain "spread" above Libor: A company with decent credit, for example, might pay an interest rate of Libor plus one-half percentage point. A risky "subprime" mortgage loan might carry an interest rate of Libor plus more than six percentage points.
Today, Libor rates are set for 15 different loan durations -- from overnight to one year -- and in 10 currencies, including the pound, the dollar, the euro and the Swedish krona. They serve as the basis for payments on trillions of dollars in corporate loans, mortgages and student loans. Libor rates are also used to set the terms of more than $500 trillion in "derivatives" contracts such as interest-rate swaps, which companies all over the world, including U.S. mortgage guarantors Fannie Mae and Freddie Mac, use to protect themselves against sudden shifts in the difference between long-term and short-term interest rates.
When banks want to borrow money, they contact banks directly or phone a loan broker, such as ICAP PLC in London. Much of the interbank lending takes place between 7 a.m. and 11 a.m. London time. In broker speak, a bank might ask for a "yard" -- one billion in a designated currency. Brokers communicate with bank clients by phone or through desktop voice boxes, which are faster. At ICAP, brokers track bids and offers by looking up at a big whiteboard above the trading floor, where a "board boy" posts information. The actual rates at which banks borrow from each other are known only to the lenders and borrowers, and possibly to their brokers.
Every morning by 11:10 London time, "panels" of banks send data to Reuters Group PLC, a London-based business-data and news company, on what it would cost them to borrow a "reasonable amount" in a designated currency. The dollar Libor panel, for example, consists of 16 banks, including U.S. banks Bank of America Corp. and J.P. Morgan Chase & Co. and U.K. banks HBOS PLC and HSBC Holdings PLC. Reuters uses the reported borrowing rates to calculate Libor "fixings." To reduce the possibility that any bank could manipulate an average by reporting a false number, Reuters throws out the highest and lowest groups of quotes before calculating averages.
Justin Abel, global head of data operations for Reuters, said in a statement that his company's role is solely to calculate fixings based on the information provided by banks. "It is their data alone we distribute. Reuters is purely the facilitator," he said.
Wary of Lending
The global financial crisis that began last summer has made it more difficult for banks to package and sell all kinds of loans as securities, as well as to issue bonds and short-term IOUs to investors. Increasingly, banks have turned to the interbank market to borrow cash. But their mounting losses on mortgage securities and other investments have raised fears that a major institution could go bust.
That's made banks increasingly wary of lending to one another.
Such jitters have made many banks unwilling to extend loans to each other for more than one week. As a result, the rates they quote for loans of three months or more are often speculative, because there's little to no actual lending for that time period, brokers say. "It amounts to an average best guess," says Don Smith, an economist at ICAP, the London broker of interbank loans and derivatives.
These bank problems are proving costly to other kinds of borrowers around the world. One way to measure the rough cost is by comparing the three-month Libor rate with an interest rate that doesn't reflect worries about banks' financial health -- such as the yield on a three-month Treasury bill, which is backed by the U.S. government. The gap between the two stood at 1.58 percentage points Tuesday, and has averaged 1.39 percentage points since the crisis began in August. In the five years before the financial crisis started, it averaged only 0.28 percentage points.
(This is a decent example of the problem of lack of true price discovery in rigged markets. - Jesse)
Citigroup's Mr. Peng believes banks could be understating even those abnormally high Libor rates. He notes that the Federal Reserve recently auctioned off $50 billion in one-month loans to banks for an average annualized interest rate of 2.82% -- 0.1 percentage point higher than the comparable Libor rate. Because banks put up securities as collateral for the Fed loans, they should get them for a lower rate than Libor, which is riskier because it involves no collateral. By comparing Libor with that indicator and others -- such as the rate on three-month bank deposits known as the Eurodollar rate -- Mr. Peng estimates Libor may be understated by 0.2 to 0.3 percentage points.
Other Benchmarks
In one sign of increasing concern about Libor, traders and banks are considering using other benchmarks to calculate interest rates, according to several traders. Among the candidates: rates set by central banks for loans, and rates on so-called repurchase agreements, under which borrowers provide banks with securities as collateral for short-term loans.
In a report published in March by the Bank for International Settlements, economists Jacob Gyntelberg and Philip Wooldridge raised concerns that banks might report incorrect rate information. The report said that banks might have an incentive to provide false rates to profit from derivatives transactions. The report said that although the practice of throwing out the lowest and highest groups of quotes is likely to curb manipulation, Libor rates can still "be manipulated if contributor banks collude or if a sufficient number change their behaviour."
A well-informed explanation of how we got to where we are. Relevant even more now perhaps since Mr. Gramm, among other things, is John McCain's economic advisor.
Michael Greenberger is the Director of the Center for Health and Homeland Security (CHHS) at the University of Maryland and a professor at the School of Law. In 1997 Professor Greenberger left private practice to become the Director of the Division of Trading and Markets at the Commodity Futures Trading Commission. In that capacity, he was responsible for supervising exchange traded futures and derivatives. He also served on the Steering Committee of the President's Working Group on Financial Markets, and as a member of the International Organization of Securities Commissions' Hedge Fund Task Force. He has frequently been asked to speak both in the media and at academic gatherings about issues pertaining to financial regulation, and has appeared on the ABC Evening News, The Jim Lehrer News Hour, and C-Span to discuss financial issues arising out of the Enron, Arthur Anderson, and WorldCom, and Refco failures.
