The LIBOR scandal will roll and roll for years, as regulators investigate and – if you believe the press – pretty much the entire world litigates against banks (doubtless Claims Management Companies have their very best people poring over templates for complaints letters as I write).
The core issues of the scandal seem to fall into two categories:
- Traders manipulating LIBOR to gain trading advantages
- Banks artificially deflating LIBOR to avoid implying their overall health was in decline and as a result spooking the markets
The first issue is being picked up by the media and politicians as yet more evidence that banks aren’t trustworthy – if this seems to have more than a sniff of the tomato calling the strawberry red, then the irony appears lost on those fulminating over the last week.
The second issue has more of an ‘untruth for the greater good’ feel to it, as destabilising the system – as a result of the world knowing banks didn’t trust each other – might have had broader implications.
However, as usual with scandals, the appetite to jump into enquiries and find scapegoats seems to run far ahead of broader questions, such as: what on earth is the point of LIBOR?
We’re told there are approximately $800 trillion of LIBOR linked financial instruments. That’s $800,000,000,000,000. Some are complex derivatives; some are straightforward residential mortgages; others are somewhere inbetween.
Yet this vast number (approximately ten times the GDP of the World) hinges on a number that involves:
- A small number of banks (18 for dollar LIBOR, 16 for Sterling LIBOR)
- Reporting on how much they think it would cost them to borrow from other banks
- At just before 11.00 each morning (presumably tea and biscuits then turn the cost of borrowing on its head)
- The upper and lower estimates are removed and the middle eight submissions are averaged to give the final number
If this sounds to you like the kind of maths problems presented to 10 year olds, usually involving a grocer trying to price apples and pears, then I agree.
A number of people have stated – some with a smidge too much hindsight to be taken seriously – that wouldn’t it be better if:
- Rather than report on the rate they think they could borrow at – which by default requires another party to agree to that rate – they report on the rate that they would lend at: something entirely within their control
- The counter argument is that they would lend at different rates to different banks, but it’s also unlikely that any one bank could borrow at the same rate from all others
- Even more revolutionary: report the rate at which banks actually lend to each other!
- It doesn’t seem beyond the realms of possibility to track and report actual transactions – albeit the market may often be too thin to have anything worthwhile to report… this seems more of a reason not to use/report LIBOR at all, than to make up an imaginary world of endless liquidity
However, this still doesn’t get to the nub of why so much ($800 trillion) should depend on something so irrelevant?
- The purpose of banks is not to lend to each other, but to borrow from depositers and lend to borrowers and with a fair wind help the economy along the way, whilst taking a reasonable margin in the middle
- Banks don’t fund to any significant level (if at all) at LIBOR – any cursory review of best buy ISA tables or Credit Default Swaps tell us that true funding costs are much (much) higher
- Having a measure that’s broadly the same as asking 16 children what they would like to be when they grow up – and presumably having ‘a time travelling Unicorn’ announced at 11 o’clock each morning – with the occasional ‘Peperami farmer’ thrown in to give us confidence that everything is above board and transparent – doesn’t seem the most logical way to run financial services
The unfit-for-purpose nature of LIBOR throws up yet another “asleep on the job” accusation at regulators. Whilst obsessing about the minutia of investment and mortgage selling, they’ve allowed an apparently irrelevant, and at best out dated, measure to be critical to the world of finance – and be default the world of us.
You can rightly accuse me of writing this with hindsight in abundance (don’t bother searching for my 2006 blog about problems with LIBOR, I never thought about it, let alone wrote about it), but monitoring and regulating the efficacy of financial markets is not my job – it is the job of the Bank of England and the FSA – it doesn’t seem ludicrous to hope that at least one might have enquired not only as to whether the rules of LIBOR were being followed, but also whether LIBOR itself was relevant?
Complexity has created too many people who specialise in having a deep knowledge of very narrow subjects. In all walks of life, we need a lot more people who see their job as to step back and challenge the things that the rest of us accept far too easily.