They're messing with LIBOR - UhOh!
May 30, 2008 3:25 AM Subscribe
Underlying several hundred thousand Student Loans, millions of Adjustable Rate Mortgages and trillions of dollars worth of financial derivatives is the London Interbank Offered Rate, or LIBOR. Launched in 1986 by the British Bankers' Association (BBA), LIBOR is the most widely used benchmark of short term interest rates.
And with the recent credit market difficulties still fresh in the minds and impacting the balance sheets of many market participants, the way LIBOR is calculated - and the interest rates charged - may be changing.
While the role of Central Banks is to set official interest rates, commercial banking institutions are free to set their own rates as determined by market pressures. As market driven rates often deviate from official rates, BBA's LIBOR is intended to accurately reflect the true cost of borrowing.
Market participants agree that under normal conditions LIBOR rates accurately reflect the true cost of capital. However the recent credit crunch raised concerns about LIBOR. Specifically, it is believed some banks understated their true borrowing costs to avoid undue attention from regulatory officials.
On Friday May 30th the BBA will issue a report detailing why LIBOR didn't accurately reflect short term interest rates, and what will be done to correct this problem. Even through BBA are not expected to introduce potentially market destabilising, broad changes many participants are rattled by the prospect of any change to such an important metric.
But lost credibility is difficult to regain: many trading desks have already moved away from LIBOR to alternatives such as the OIS Swap Spread - a metric favoured by the US Federal Reserve - to measure short term interest rates, and competitors are moving quickly to offer their own interest rate indexes.
Considering both the wide spread use of LIBOR and the still fragile state of the financial markets, BBA's report, expected today at 17:00 GMT, is widely anticipated.
And with the recent credit market difficulties still fresh in the minds and impacting the balance sheets of many market participants, the way LIBOR is calculated - and the interest rates charged - may be changing.
While the role of Central Banks is to set official interest rates, commercial banking institutions are free to set their own rates as determined by market pressures. As market driven rates often deviate from official rates, BBA's LIBOR is intended to accurately reflect the true cost of borrowing.
Market participants agree that under normal conditions LIBOR rates accurately reflect the true cost of capital. However the recent credit crunch raised concerns about LIBOR. Specifically, it is believed some banks understated their true borrowing costs to avoid undue attention from regulatory officials.
On Friday May 30th the BBA will issue a report detailing why LIBOR didn't accurately reflect short term interest rates, and what will be done to correct this problem. Even through BBA are not expected to introduce potentially market destabilising, broad changes many participants are rattled by the prospect of any change to such an important metric.
But lost credibility is difficult to regain: many trading desks have already moved away from LIBOR to alternatives such as the OIS Swap Spread - a metric favoured by the US Federal Reserve - to measure short term interest rates, and competitors are moving quickly to offer their own interest rate indexes.
Considering both the wide spread use of LIBOR and the still fragile state of the financial markets, BBA's report, expected today at 17:00 GMT, is widely anticipated.
Also, releasing at 17:00 on a Friday? You already know the news is bad.
I thought it was accepted practice to release any sort of information that might have a disruptive effect on the markets after hours.
posted by grouse at 4:05 AM on May 30, 2008
I thought it was accepted practice to release any sort of information that might have a disruptive effect on the markets after hours.
posted by grouse at 4:05 AM on May 30, 2008
This is the first of several shoes to drop I think. The ones that I'm waiting for (but I'm not holding my breath) are the US M3 statistic and (very relatedly) for Core CPI figures to take into account food and energy. If you look at the real money supply and the real inflation figures the financial world looks, um, different.
posted by unSane at 4:39 AM on May 30, 2008
posted by unSane at 4:39 AM on May 30, 2008
Well, as long as the lenders and banks are able to dismiss their mistakes and deceptions by making consumers pay for it, it's all good, right? The invisible wringing hand, and all that.
posted by Thorzdad at 5:07 AM on May 30, 2008
posted by Thorzdad at 5:07 AM on May 30, 2008
"The Libor numbers that banks reported to the BBA were a lie,'' said Tim Bond, head of global asset allocation at Barclays Capital in London. "They had been all along. The BBA has been trying to investigate them and that's why banks have started to report the right numbers."
So there's nothing wrong with LIBOR per se other than it relies on banks self-reporting truthfully.
Just print some more money and stop whinging.
posted by three blind mice at 5:16 AM on May 30, 2008
So there's nothing wrong with LIBOR per se other than it relies on banks self-reporting truthfully.
Just print some more money and stop whinging.
posted by three blind mice at 5:16 AM on May 30, 2008
unSane: I don't understand, if you add food and energy you just get headline CPI. Are you saying they should redefine core CPI based on which sectors are currently the most volatile?
posted by thrako at 5:37 AM on May 30, 2008
posted by thrako at 5:37 AM on May 30, 2008
Tangentially related: Supervisors Covered Up Risky Loans
posted by Kirth Gerson at 6:18 AM on May 30, 2008
posted by Kirth Gerson at 6:18 AM on May 30, 2008
There's a good round up of various comments on the LIBOR situation by Felix Salmon - JPM's researchers seem to think it's ok(ish).
Interestingly, the place it's having the biggest effect is in Spain where it seems the entire mortgage market is linked to the 3 month LIBOR number and the housing market is now in full scale collapse and could bring down the real economy too.
posted by patricio at 7:23 AM on May 30, 2008
Interestingly, the place it's having the biggest effect is in Spain where it seems the entire mortgage market is linked to the 3 month LIBOR number and the housing market is now in full scale collapse and could bring down the real economy too.
posted by patricio at 7:23 AM on May 30, 2008
Another interesting and link-rich financial post from Mutant. His semi-retirement is turning out quite well for us.
posted by leotrotsky at 7:30 AM on May 30, 2008 [1 favorite]
posted by leotrotsky at 7:30 AM on May 30, 2008 [1 favorite]
I'm not really qualified and don't have the background to comment on the financial aspects of this, but one part of the post caught my attention: "competitors are moving quickly to offer their own interest rate indexes."
It strikes me as odd that there's much "competition" in interest rate indexes. It seems like a pretty thankless job, honestly -- who pays for the index to be maintained, anyway? And what does the entity who maintains it get as benefit?
The BBA seems like it's basically a trade association; although it's not clear whether they're formally a non-profit, it doesn't seem like they're really designed as a revenue-generating enterprise either. They exist to serve their member banks, who assumedly pay the bills, and produce the LIBOR (and other metrics) as a means to this end.
Trying to "compete" with something that's inherently unprofitable doesn't seem like something to get excited about, honestly.
posted by Kadin2048 at 9:22 AM on May 30, 2008
It strikes me as odd that there's much "competition" in interest rate indexes. It seems like a pretty thankless job, honestly -- who pays for the index to be maintained, anyway? And what does the entity who maintains it get as benefit?
The BBA seems like it's basically a trade association; although it's not clear whether they're formally a non-profit, it doesn't seem like they're really designed as a revenue-generating enterprise either. They exist to serve their member banks, who assumedly pay the bills, and produce the LIBOR (and other metrics) as a means to this end.
Trying to "compete" with something that's inherently unprofitable doesn't seem like something to get excited about, honestly.
posted by Kadin2048 at 9:22 AM on May 30, 2008
According to this "breaking news" from WSJ:
British Bankers' Association committee plans to keep same 16 banks' quotes to calculate Libor rate, but says it plans more oversight.
posted by preparat at 10:28 AM on May 30, 2008
British Bankers' Association committee plans to keep same 16 banks' quotes to calculate Libor rate, but says it plans more oversight.
posted by preparat at 10:28 AM on May 30, 2008
thrako, our current inflation measures are hopelessly broken. We measure inflation by the cost of LCD TVs and other consumer breakables. Meanwhile food, energy and most housing costs -- the actual costs of existence are factored out. But hey, I guess you could always eat your TV, live in the fridge, and burn your XBox to keep warm. No?
(This sleight of hand allows both employers and governments to pretend to keep wages and social security in pace with inflation, while reducing real incomes. By combining this with obscuring the real money supply, the fact that the government is printing money as fast as it can to reduce the real value of debt held by foreign countries can be hidden from public view. That's my take, anyway. No wonder oil and gold are up).
posted by unSane at 2:01 PM on May 30, 2008 [2 favorites]
(This sleight of hand allows both employers and governments to pretend to keep wages and social security in pace with inflation, while reducing real incomes. By combining this with obscuring the real money supply, the fact that the government is printing money as fast as it can to reduce the real value of debt held by foreign countries can be hidden from public view. That's my take, anyway. No wonder oil and gold are up).
posted by unSane at 2:01 PM on May 30, 2008 [2 favorites]
Here is an article that more fully explains unsane's point.
posted by Kirth Gerson at 5:42 PM on May 30, 2008
posted by Kirth Gerson at 5:42 PM on May 30, 2008
Another interesting and link-rich financial post from Mutant. His semi-retirement is turning out quite well for us.
I know! How do I configure MeFi so I just get MutantFilter?
It's funny how I spend more time reading commentary blogs by analysts about "real-world finance" and less time watching the actual numbers on my quote screen. Just like politics, history, and everything else in the human world, there's a huge disconnect between perceived reality and the way things really are.
My favorite thing: financial market theorists (or politicians) who don't want to believe that human nature needs to be factored into any policy. Like we aren't just a bunch of greedy hungry little piggies, but instead enlightened, ethical consumers, all...
We'll never really know, but boy do I wish I could see the true reality of how bad the financial markets have been in the last year - all the hidden secret numbers, the scary calculations that nobody will ever commit to email, the dangerous shell game that is being played by people on the edge.
And a photo spread of some random fund managers and what they did with their huge bonus income from 2004, 2005, and 2006...
(sorry for the non-LIBOR tangent, but wow - I always thought of LIBOR as a fact, and not something to be gamed. how naïve of me, I know. I feel like a classical physicist, post-Einstein.)
posted by EricGjerde at 7:29 PM on May 30, 2008
I know! How do I configure MeFi so I just get MutantFilter?
It's funny how I spend more time reading commentary blogs by analysts about "real-world finance" and less time watching the actual numbers on my quote screen. Just like politics, history, and everything else in the human world, there's a huge disconnect between perceived reality and the way things really are.
My favorite thing: financial market theorists (or politicians) who don't want to believe that human nature needs to be factored into any policy. Like we aren't just a bunch of greedy hungry little piggies, but instead enlightened, ethical consumers, all...
We'll never really know, but boy do I wish I could see the true reality of how bad the financial markets have been in the last year - all the hidden secret numbers, the scary calculations that nobody will ever commit to email, the dangerous shell game that is being played by people on the edge.
And a photo spread of some random fund managers and what they did with their huge bonus income from 2004, 2005, and 2006...
(sorry for the non-LIBOR tangent, but wow - I always thought of LIBOR as a fact, and not something to be gamed. how naïve of me, I know. I feel like a classical physicist, post-Einstein.)
posted by EricGjerde at 7:29 PM on May 30, 2008
Thanks for that article, KG. Good reading. When you see those NASDAQ charts slanting upwards, it seems so much less impressive when you know inflation is bumping 9%.
posted by unSane at 8:05 PM on May 30, 2008
posted by unSane at 8:05 PM on May 30, 2008
Yeah, I have to second that- Kirth's linked article is really a great read. some straight talk about the actual numbers and how they are being gamed.
And we all know that inflation is really happening like this, don't we? If you've gotten yearly raises in the 4% to 5% range, it's remarkable to note that while that is theoretically more than inflation (per the cooked books) it sure doesn't feel like it at all. I had more disposable money as a 21 year old, earning less than half my income now- even factoring in some life changes it's not that different, but everything just costs significantly more less than 10 years later.
Even discounting rampant commodity speculation it's impossible to ignore. And the fact that such a façade is made to cover it up - and everyone plays along... what to believe, now? is anyone telling the truth?
posted by EricGjerde at 9:02 PM on May 30, 2008
And we all know that inflation is really happening like this, don't we? If you've gotten yearly raises in the 4% to 5% range, it's remarkable to note that while that is theoretically more than inflation (per the cooked books) it sure doesn't feel like it at all. I had more disposable money as a 21 year old, earning less than half my income now- even factoring in some life changes it's not that different, but everything just costs significantly more less than 10 years later.
Even discounting rampant commodity speculation it's impossible to ignore. And the fact that such a façade is made to cover it up - and everyone plays along... what to believe, now? is anyone telling the truth?
posted by EricGjerde at 9:02 PM on May 30, 2008
our current inflation measures are hopelessly broken. We measure inflation by the cost of LCD TVs and other consumer breakables. Meanwhile food, energy and most housing costs -- the actual costs of existence are factored out. But hey, I guess you could always eat your TV, live in the fridge, and burn your XBox to keep warm. No?
Core CPI is important for prediction. The large, transitory swings in food and energy prices mean that the current headline CPI is a poor gauge of future headline CPI, which is what matters for policy makers. No one is saying that consumers don't eat and don't drive.
Also, I don't have the numbers in front of me, but I believe that over the long run core CPI has tracked total CPI fairly closely. I can't really speak to the owner's equivalent rent issue.
posted by thrako at 10:20 PM on May 30, 2008
Core CPI is important for prediction. The large, transitory swings in food and energy prices mean that the current headline CPI is a poor gauge of future headline CPI, which is what matters for policy makers. No one is saying that consumers don't eat and don't drive.
Also, I don't have the numbers in front of me, but I believe that over the long run core CPI has tracked total CPI fairly closely. I can't really speak to the owner's equivalent rent issue.
posted by thrako at 10:20 PM on May 30, 2008
Unfortunately filtering out the short term variance in food/energy/housing inflation by removing them from the inflation index 'cures' the problem in the same sense that death 'cures' everything.
The UK seems to manage its affairs just fine by tracking the Retail Price Index which includes food and energy. Download the PDF to see what they track.
posted by unSane at 7:54 AM on May 31, 2008
The UK seems to manage its affairs just fine by tracking the Retail Price Index which includes food and energy. Download the PDF to see what they track.
posted by unSane at 7:54 AM on May 31, 2008
Here's a chart from the hardcore investing site Seeking Alpha which shows the spread between headline and core inflation measures, plus a discussion of what it means.
posted by unSane at 7:56 AM on May 31, 2008
posted by unSane at 7:56 AM on May 31, 2008
>but instead enlightened, ethical consumers, all...
Homo Economicus is the term, I gather. The bloke who can, unlike a simple Homo Sapiens, see through the several bullshit assumptions that underpin neo-classical economics. Homo Economicus has perfect knowledge.
It'd be cool to be him.
posted by pompomtom at 2:47 AM on June 1, 2008
Homo Economicus is the term, I gather. The bloke who can, unlike a simple Homo Sapiens, see through the several bullshit assumptions that underpin neo-classical economics. Homo Economicus has perfect knowledge.
It'd be cool to be him.
posted by pompomtom at 2:47 AM on June 1, 2008
In case anyone is still following this thread: Libor to Be Set by More Banks as BBA Boosts Scrutiny
June 10 (Bloomberg) -- The British Bankers' Association, yielding to pressure from investors and regulators, will increase the number of banks that set the London interbank offered rate in the biggest change to Libor in 10 years.
The London-based trade group will also ``take soundings'' on adding a second survey of members to reflect U.S. trading hours when in sets the global benchmark rate, it said today in an e-mailed statement. Libor, used to calculate rates on about $360 trillion of financial products, was last changed in 1998.
posted by Mutant at 5:02 AM on June 10, 2008
June 10 (Bloomberg) -- The British Bankers' Association, yielding to pressure from investors and regulators, will increase the number of banks that set the London interbank offered rate in the biggest change to Libor in 10 years.
The London-based trade group will also ``take soundings'' on adding a second survey of members to reflect U.S. trading hours when in sets the global benchmark rate, it said today in an e-mailed statement. Libor, used to calculate rates on about $360 trillion of financial products, was last changed in 1998.
posted by Mutant at 5:02 AM on June 10, 2008
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Also, releasing at 17:00 on a Friday? You already know the news is bad.
posted by PenDevil at 3:30 AM on May 30, 2008