http://www.bbc.com/news/business-26584942
Monday, April 28, 2014
US regulator sues 16 banks for alleged Libor rigging
Here is an interesting article on some banks that are being sued for malpractice. This article voices, to some extent, some of the themes that Admati and Hellwig discuss in Chapter 13 of The Bankers' New Clothes.
http://www.bbc.com/news/business-26584942
http://www.bbc.com/news/business-26584942
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I am not as familiar with situation in London, but to me it sounds as if the idea of LIBOR should be reconsidered. I am not familiar with the benefits of setting the rate on a daily basis. Can anyone answer 1. What the benefits are to setting a daily rate, and 2. If it is beneficial, should the U.S. consider something along those lines (obviously with some regulation).
ReplyDeleteFrom what I've read, LIBOR is used primarily as a benchmark for short term credit instruments. Many different derivatives (e.g. interest rate swaps, swaptions, OIS) are tied to the LIBOR rate. So, for example, a bank could quote its interest rate swap with another bank as the 3 month USD LIBOR + 20bps. Or, a loan to an individual could be charged with an interest rate of LIBOR + 50bps.
ReplyDeleteBecause it is a measure for short term borrowing, I think they like to have the quote set everyday (though honestly that is just a guess). I think having such a rate is important (at least the market thinks so because approximately $350 trillion dollars of derivative and financial products are tied to this rate).
The scandal arose from the way in which LIBOR was set. The process simply involved a group of people talking about what they felt was an accurate borrowing rate; there was nothing quantitative or historical about the process whatsoever. Regulators started to get suspicious when they noticed discrepancies between submitted LIBOR rates and other market-determined metrics of risk associated with a bank (e.g. CDS spreads, commercial paper rates). From my understanding, recent changes have sought to add more layers of oversight in the rate-setting process, as well as inclusion of a larger numerical component.
Sorry for the long-winded answer Mark, but hopefully it helps a bit.
This seems to be another issue with regulation and accountability. I may be oversimplifying, but it seems a lot of the issues in the class stem from deregulation and imperfect information. I think as humans we have a natural drive to succeed, which is why the free market should work in theory, but not everyone is held to the same standard. The banks involved in the LIBOR scandal seem to be doing what they were in the US, by giving false information to regulatory agencies that are failing at their jobs.
ReplyDeleteSanjay that definitely helps. I did not realize that $350 trillion dollars were tied to the LIBOR rate. It would make more sense though that because there is so much money involved that there would be more regulation. It is interesting that they would want to set the rate everyday, as it just seems like more work for the companies. But then again, the short-term investments are probably one of their biggest money-makers because of the amount of money involved.
ReplyDeleteThe LIBOR rate scandal seems to be like a portfolio of unrealized debts: a number of fines have already been imposed on the banks who participated, but its clear the full extent of the fines have yet to be realized.
ReplyDeleteThat said, the daily rate will probably continued to be gamed as best as possible. As you all have said before me, their is a great deal to be made in short term debt markets.
I don't know how this might be related, but it reminds me one of the chapter in 'Bankers New Clothes' the author discussed about the competition between the banks in different countries. Every bank tries to set the regulation that will give them a competitive edge. None of the banks seem to be caring about the regulations at all. In the international arena, if banks in other countries are getting advantage because of the power and location, then other complain about it. The US institutions might have done the same thing if they got the chance. As they didn't get the cut, they are calling it unfair and decided to proceed with the legal action.
ReplyDeleteSanjay, from your description, it seems as though LIBOR is set up in a way where banks pretty much regulate themselves (monitored by the government, yes, but as Jack stated it's very difficult for them to be effective). As Mark pointed out, more regulation seems appropriate. Banks can turn a huge profit through rigging the rate, so there must be a strong disincentive to discourage this behavior.
ReplyDelete