Wheatley Review

  • 28 Sep 2012 at 11:31 AM

It’s The Beginning Of The End For Danish Kroner Libor

Why would you want to be a Libor bank? It’s unpaid work, in that every day you need to get on the phone to Reuters and say where you can borrow across 150 tenors and currencies in which you mostly don’t borrow, which one assumes taxes the imagination. And there’s potential badness, though the specifics vary over time: in 2008 the badness was “if we submit a high Libor people will think we can’t fund ourselves and there will be a run”; in 2012 the badness is “if we submit a bad Libor we’ll go to jail.”

So why do it? Some part of the answer is a certain kind of public-spiritedness: you’re JPMorgan, you trade a zillion dollars of interest-rate swaps, the swaps reference Libor, there needs to be a Libor, you and your friends who trade swaps get together and agree to make a Libor so that you can have a swaps market, and then you keep making that Libor every day. We’ll go be cynical in a minute, but let’s take sec to appreciate that this is a real thing and surely the primary motivator behind Libor. The financial industry is actually good, in a way that say the cell-phone mapping industry is not, at getting together and solving coordination problems via committee in a way that creates new markets for everyone to benefit from. Everyone on the committee, I mean.

The other part of the answer is of course “once you’ve set up this swaps market, you can manipulate it to your profit.” This to some extent counteracts the preceding public-spiritedness – your zillion-dollar swaps market depends on your benchmark being reliable, so if you manipulate it you screw things up for everyone – but in meaningful ways it doesn’t. For one thing every market consists of traders cheating each other within controlled bounds; it’s just about plausible to think that Libor submitters thought of themselves like the bond trader who tells his customer that he just can’t afford to part with these bonds for less than 102 when in fact he picked them up at 85, and that they figured that their cheating Libor down would be balanced by some other similarly dodgy character at another bank cheating Libor up, creating a system that is deceptive in every particular but trustworthy in aggregate.1 For another thing, you have a world and can go look at it, and empirical investigation will tell you that swaps volume was untroubled by actual Libor cheating through 2010, and doesn’t seem especially troubled (stripping out effects of economic contraction, concerns on counterparty credit risk, increased clearing and collateral requirements, netting down, etc.) by the exposure of Libor cheating in 2012. So go ahead and cheat.

So there you are chugging along being a Libor panel bank, submitting Libors that are honest enough to foster a robust swaps market, but dishonest enough to foster robust profits for you in that market, and bang, this: Read more »