Since I come from a buyout background, it is hard for me to imagine anything more unsettling than the revelation that LIBOR might be… well… fixed.
The London InterBank Offered Rate (see what I did with the formatting there?) is a disproportionately serious figure used as the basis for Greenspan-only-knows how many debt structures. That its utility as a baseline risk measure would be called into question (even in the absence of any real manipulation or inaccuracy) is, in itself, very alarming.
LIBOR isn’t a market priced rate. There is, at least so far as I am aware, no LIBOR index (LIX?) to trade on. Instead, a rather old and more than Byzantine mechanism is used to report the figure to Reuters. Specifically:
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.
Of course, what the banks report to Reuters is a “best guess,” of sorts, and, accordingly, in times of limited liquidity, reliability of the figure is less than stellar. But add to this the prospect that banks are understating the figure to disguise their distress and you have a rather volatile brew.
If you can’t rely on banks, who can you rely on?
Ok, so that was a joke.
Bankers Cast Doubt On Key Rate Amid Crisis [WSJ]
Stressed Banks Underreporting LIBOR Rates [Naked Capitalism]
The financial markets underestimate systemic risk because of its recursive nature thereby artificially pricing debt too low? Who knew?
nice to see you’re not sleeping in on your vacay EP. Heaven knows I would/do.
Have you noticed a creep in the past 5+ years of (at least US debt) carrying t+x rate structures? I recall seeing some, but not as much as one would expect, given what you point out here…
Isn’t it London Interbank Overnight Rate?
by basing a ton of debt instruments on LIBOR, you are creating a magnet for black swans to hang out…
So maybe you now are beginning to realize how little you can price risk in the traditional sense…?
OK, so I did the google search AFTER posting that question. “Offered Rate” it is. Duh.
“great president, lousy bell ringer”
i have a man crush on mark haines.
LIBID/LIBOR… Bid/Offer
Duh indeed. How could you have one month- and three month-LIBOR if it the “O” was for overnight?
maybe he thought O stood for orgasm?
The O is for oblivious
also it was probably a her, we all know women don’t under stand finance or abbreviation
The O should have been for obvious…surveys suck. This “potential” problem has always been around. The only difference now is that the folks in associationtown regulatoryville are just now realizing the potential for abuse (yes, I”m talking to you ISDA and Bank for International Settlements).
@ 9:53: or where spaces go.
oh wait.
“also it was probably a her, we all know women don’t under stand finance or abbreviation”
Watch yourself.
@10.08 ep– What is the breakdown of male/female execs in the banks/brokers who have unleashed the current problems on us? Do you know?
I often wondered why some mortgages in the US are tied to a rate in jolly ol’ England. Anybody? Sorry if the question is stupid or remedial, but I’ve asked numerous people in finance/mortgages and have never gotten an answer because they all didn’t know either.
“Watch yourself.”
I got your, LIX right here, sweetheart.
“I got your, LIX right here, sweetheart.”
And I’ve got your IP address. :)
@10:23 Unless he’s using a proxy server or some place like a cafe, then, um, you don’t have his real IP. Just pointing it out.
@10.18: the 16 banks each show 15 rates for borrowing from each other in different CCS, such as $/£/€. Ergo not tied to GBPL. If they were tied to £ the default rates would have soared past 3% a long long time ago.
@11:17 Thanks, but I still don’t understand how or why American mortgage interest rates are tied to European banks’ lending rates. I thought American lenders were borrowing from the Fed or each other. Obviously I’m no expert on mortgage lending or LIBOR. I am just curious as to how American housing can be tied to European lenders. I don’t see any interest rates tied to Asian lenders for example.
Hah! I knew eventually a dealbreaker agent would start using our IP addresses against us.
i believe many SUBPRIME adjustable rate mortgages are tied to Libor, rather than Fan Mae. I guess a logical reason for this would be that the £ fwd curve is a lot more attractive to lenders than the € curve. There is no reason at all why they cant offer in different CCS. It is possible in the UK to get a mortgage tied to € if you want. Why not? The banks can hedge their exposure on the street and it is just a curve and fx play
sorry – should read: “I guess a logical reason for this would be that the £ fwd curve is a lot more attractive to lenders than the $ curve”
fcking €, fcks up even keyboards.
There is no logical reason, it’s just an index like the DJIA or S&P. Also US LIBOR is what rates are tied to and represent the rate the BBA banks would loan each other in USD, not lbs or euros. This is how I understand it, please feel free to correct me.
@11:27 – the group of 16 includes 2 US banks, as well as Japanese banks and so on. They’re not all European.
US banks are borrowing in the money markets, which are truly international.
@11:47 – Subprime mortgages IN THE US are tied to dollar LIBOR, not euro LIBOR or poundsterling LIBOR.
Huge amounts of student loans, credit cards, and other US debts are also tied to LIBOR rather than the Fed Rate, because LIBOR is seen as being closer to a true market rate of interest.
The names LIBOR and Eurodollars are historical artifacts.
“eurodollar” is a brand name (like kleenex or saran wrap) that now describes all such products -
http://en.wikipedia.org/wiki/Eurodollar
LIBOR is widely used by crooked mortgage brokers because it is usually the highest published index.
They quote LIBOR plus 2.00 instead of Federal Funds plus 2.25 because it sounds lower.
Simple question; simple answer. The real question is: Why did US mortgage regulators allow the use of a Foreign interest rate index?
Answer: There hasn’t been any regulation of the US mortgage market in years, that’s why.