Nothing like putting your foot in mouth in public and chewing.
Avinash Persaud, who is listed at VoxEU as “Chairman, Intelligence Capital Limited; Emeritus Professor, Gresham College; Senior Fellow, London Business School,” put up a “nothing to see here” post on the Libor scandal.
It’s clear from this piece that Persaud hasn’t deigned to do basic homework, like reading the FSA’s letter to Barclays, which describes its findings from its investigation and recounts the regulatory violations. For instance, Persaud describes the scandal as having “two phases”, June 2007 to June 2008, and after the collapse of Lehman. The FSA also described two phases of manipulation, but the first was 2005 to 2007, in which Barclays derivatives traders were seeking to move specific Libor indexes, most often the one month or three month Libor, apparently by small amounts (targets of single basis point moves were mentioned), to improve the value of trades they had on. The later phase was in 2007 to 2009, when banks were lowering Libor in an effort to signal that they were healthier than they were. (Within this period, Persaud makes a case that immediately post Lehman, there was no interbank lending market, so it made sense to have the banks keep posting Libor, given all the instruments priced off of it). And his air-brushing out the 2005-7 manipulation also means he does not have to deal with charges made by many and recounted by the Economist, that the gaming of Libor goes back 15 years or more before that 2005 date.
To get to the embarrassing part, we need to review how Libor is set. 16 banks submit a figure that is supposed to represent their cost of borrowing/lending at various maturities in various currencies. For each index value, say one month Euribor, of the 16 value provided, the highest four and lowest four are omitted and an average is taken of the remaining eight.
This is the part of Persaud’s piece that is the stunner:
How much collusion would be necessary to manipulate rates?
This method of estimation – where the extremes are trimmed – makes it impossible for one bank, which has a large net lender or borrower position, to manipulate the Libor rate on its own.
• Any manipulation would need collusion by a minimum of a quarter plus one of the banks being surveyed.
• These banks would have to have similar net positions – so that their interests were aligned in favour of the collusion – and the offsetting position (these banks are lending and borrowing from each other and so someone’s lending is another’s borrowing) would have to be so widely distributed so as not to trigger an offsetting collusion.In other words, manipulation of these rates for private profit would be difficult to arise or sustain.
This is completely wrong. The ease or difficulty of manipulating Libor is a function of the dispersion of the submissions, and whether the submitter can make an accurate guess as to how high or low a bid it will take for his value to be knocked out on the high or low end. If your submission would have been among the ones in range and you move your submission to a level where you are pretty sure you’ll be excluded, you’ll effect a change in the submissions chosen to be averaged. And the Barclays traders understood that this was an effective strategy. The e-mails included in the FSA release has multiple instances of traders pleading with the submitters to put in a bid that was high or low enough to be excluded from the calculation.
To illustrate, just take a series of submissions that are dispersed (for convenience, percentage signs omitted):
1.0, 1.1, 1.2, 1.3, 1.4, 1.5….2.4, 2.5
Let’s say your submission would have been one of the ones in the middle. We’ll pick 1.8.
So the average per the Libor rules would be:
Knock out four bottom, so 1.3 and below.
Knock out 4 top, so 2.2 and above.
Average the rest (1.4, 1.5, 1.6, 1.7, 1.8, 1.9, 2.0. 2.1): 1.75
Now assume you have nefarious reasons for wanting to move Libor lower. Instead of submitting 1.8, you bid someplace really low but acceptable, say 1.0.
The effect in the 8 numbers to be averaged is to replace 1.8 (the number that would have been in) with 1.3 (the number formerly excluded but now included) This is a difference of 0.5 in the total to be averaged. Divide by 8, and you’ve moved Libor by 6.25 basis points (If you do it the hard way, you’ll see this is correct).
Now if there is less dispersion or less ability of the submitters to make good guesstimates of where they need to place their bid (actually, luck will do, but people who are out to manipulate markets don’t want to rely on being lucky), then it will take collusion to effect a change. But again, that does not mean it takes collusion on the scale asserted by Persaud.
Persaud presents some other peculiar ideas in his article. For instance:
…it was felt that banks are incentivised to submit realistic estimates of the underlying conditions because they are both substantial lenders (who would want higher Libor) and borrowers (who would want lower Libor) and they could not easily predict which they would be more of on a given day.
Note that while Persaud here is giving the theory of Libor, the rest of his piece does not voice disagreement with this part.
First, the banks borrow in the market where that particular bank can borrow. If counterparties want to lend to Bank of America today at 1% at 3 months, that’s where the price is. The fact that it might be expressed in terms of Libor is irrelevant since this borrowing does not reset. When Libor was suppressed, I was getting regular comments that the real rates were 30 to 40 basis points higher, and recent revelations have been consistent with that.
Second, it charmingly speaks of “bank” incentives. Employees, particularly traders, game their organizations all the time. The inmates may well have been running the asylum, yet Persaud refuses to acknowledge that possibility.
Third, Persaud like many others, thinks only of the implications for lending and borrowing, when as we’ve said repeatedly, the action in the Libor scandal was all about the derivatives. And remember, there are certain types of exposures where it is highly likely the dealers were largely positioned on one side of a trade and end customers on another. So dealer incentives may well have been largely consistent. For instance, one customer trade done is scale is borrowing floating rate debt short and swapping into fixed. It’s hard to think of customers who’d be natural swap providers (although the dealers may be accompanied by some Treasury departments and hedgies who are taking a speculative position).
What is the lesson of this flagrantly off-base article? That being an economist means you don’t have to bother with facts? That defending banks is so highly paid that someone like Persuad is willing to write credible-sounding drivel on their behalf? Oh, but I forgot. Mainstream economists gave advice that wrecked the global economy and they haven’t shown any remorse, much the less changed their ways.
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An interesting period to analyse is mid 2006 until mid 2007, especially 1 month libor. Pull up a chart of the fixing, and examine each bank’ s contributions. To be clear I am not accusing anyone, but I find it curious that rabobank, a AAA rated entity, submits rates that are higher than libor ( aa on average at the time?) on many days. On one day their rate is 4 bp higher than the preceding and following day! Utter BS. 2006 and early 2007 was peak liquidity and rates never budged no matter how much or how little you borrowed, especially in such a short tenor.
I note that two traders at Mitsubishi were placed on leave as their previous job was at rabobank until 2009.
Pretty interesting. It doesn’t look good.
Rabobank is AAA rated ?!? Wow.
It was aaa rated. Not anymore.
To be clear I mean Usd libor in this example.
This dude is a joke. A 6th grader that’s good at math would untuitively understand how wrong he is with regard to the averages. If this is what passes for thinking among mainstream economists (and from what I’ve seen his oversimplification, broad assumptions and sheer wrongness are par for the course amongst neoclassicals) they should all join hands and jump off a very high cliff as a service to humanity. I mean really. How do they look in the mirror without dying of shame? It does explain the insane levels of pomposity and arrogance they exhibit: anyone possessing actual useful knowledge and insight doesn’t need to slather themselves in layers of slimy smugness and superiority before they walk out the door every morning.
Yank, take it as an indicator the London ‘atmosphere’ is not as supportive of the FraudFest as they’d desired,
http://www.nytimes.com/2012/07/20/sports/olympics/olympics-leave-british-complaining-even-more-than-usual.html
police state, fraudfest, fresh hell, reign of det-
YF, he’s paid not to understand. “London” authority placement, his name sounds like a marriage of Victorian Raj and Norman Conquest within .99% Agency for his .01% Lords.
Nice debunking.
Lets debunk some more. London Interbank OFFERING Rate. You gotta love that moniker. What’s being asked and quoted are OFFERING rates, a first step in negotiating. As the question is posed each morning it’s an asking rate and not a bid rate. Now if you want to benchmark a borrowing price wouldn’t it be better to employ a current contract price?
Isn’t also true that you can offer whatever price you think is appropriate, after all you’re only rendering an opinion?
It seems that the manipulation was directed toward lowering the quote. What effect does a lower quote have? It tends to raise the value of assets that are priced using the lowered quote. There’s the fraud!
Yves,
Excellent post.
For those readers who missed the recent Richard Alford post on the economics profession, you might want to include a link.
It is important to keep pointing out that the profession has not had the decency to actually take the time to look at what caused the financial crisis before offering what are rather dangerous opinions if adopted. (my personal favorite the call for higher capital ratios before requiring the banks to recognize all their losses…. the result is a credit crunch and bank balance sheets loaded with zombie borrowers.)
R, these Neoconlib Academics are facing their own Gallipoli for their Masters.
Thanks. Your article is very enlightening. I must add that the label of “main stream economist” to the sort of drivel you depict here is indeed telling. The study of movement of speculative markets in reality is less than beneficial to society, except perhaps in extirpating chicanery. What economics ought to be about is the elucidating the means of credit issuance whereby society may foster improvements in order to raise the standard of living of its population. This is what Alexander Hamilton’s revolutionary Report on the Subject of Manufactures so trenchantly accomplished in its polemic against Adam Smith’s Wealth of Nations. http://thingumbobesquire.blogspot.com/search?q=Alexander+Hamilton
Yves,
Excellent analysis. What I’d add to the discussion is the magic word “leverage”. It’s clear from the Barclays emails released so far that the traders seeking to game the LIBOR (up or down, depending on their respective positions at the time) were looking for results in the 1 to 5 basis point range. That’s 1% to 5% OF ONE PERCENTAGE POINT OF INTEREST! (Sorry for shouting there, but the emphasis was needed). To the lay person, such a move seems so small as to be nugatory. However, when you have a futures or swap contract with a notional value of $100,000,000s, a swing of 1 basis point can mean millions of profit.
The eise of rxtraordinary leverage in the financial system that came in the 1980s and onward, and the implicit hubris behind the logic that one can know the mathematical dynamics of one’s trades so well that the corresponding reduction of loss margins is not a matter for concern, that one can dynamically hedge or, worst case, close out losing positions, is IMHO the true cause of the financial crash of 2008-2009, and one that hasn’t been corrected at all. The Darryl Duffies of the world are still writing papers full of Ito differential equations purporting to prove that risk-free trading strategies exist, and this financial nitroglycerin still permeates all the trading desks around the world.
I’m just waiting for “the fire next”. It’s going to happen and this time it’s going to burn the world down. Sadly, the 1% will be the least harmed when it does: it’s never the houses on the hills that get swept away in the floods, it is the poor peoples’ hovels and shacks.
P
p, CAPS not always shouting, can be for emphasis in texted speech, in which verbal emphasis must be heard with the eyes.
I heard him shouting and he appologised for shouting. Why, pray tell, did you feel the need to add a comment of no subjective relevance?
I agree with your observation. The belief in mathematical magic is a big “systemic” problem. To get Beard stirred up, perhaps it’s one of the false gods the bible warned about.
I think another equally bad, broad, counter-productive problem is the fixation with short-termism, going all the was down to nanoseconds.
The old saw, a watched pot never boils comes to mind. From observation, micro-managed growth prevents real growth and only leads to a superficial facade of growth.
all the WAY down to
Yves Smith,
As far as I can see from the e-mails and the graphs produced in the FSA document, the degree of distortion in the submissions was not great prior to the financial crisis. Indeed, the figure I get is lower than that of phichibe — as far as I can see, it was commonly a single basis point or even lower.
And if there was no collusion, the effect on the average LIBOR would be an eighth of this. If the submission from Barclays was kicked out, the position would be different, but even so, characteristically we are not talking, prior to the financial crisis, of a situation where figures from Barclays could be expected to shift LIBOR by a significant number of basis points.
Precisely as phichibe says, the key to this is leverage. So in one of the US Dollar LIBOR fixings the FSA discusses, the notional sum at issue was $80bn. Even an eighth of a basis point difference in interest rates, on a sum of this magnitude, generates a profit or loss which is not exactly chump change.
What I do not know is how the leverage works, to make transactions in figures of this order of magnitude a common occurrence.
The situation was materially different, in relation to EURIBOR, from the situation in relation to LIBOR. The US Dollar LIBOR panel was indeed made of sixteen banks, with the top and bottom quarters excluded. The EURIBOR panel was made of between 42 and 48 banks, with the top and bottom 15% excluded. Accordingly, the pressures to collusion were higher in relation to EURIBOR than LIBOR. And, unsurprisingly, we find that although the evidence of collusion is present in relation to both rates, it is much stronger in relation to the former.
So, essentially, we have two different, if interrelated, scandals.
The first relates to the creation of small deviations in rates applied to vast sums created by the habitual use of extraordinary levels of leverage, and is simply a matter of making profits and avoiding losses. The question here is whether this was simply a matter of a few ‘bad apples’, with, quite possibly, corruption spreading out from Barclays, from 2005 on: or whether as the Economist suggests the corruption may have started far earlier – in which case it may also have spread far wider.
The second relates to the situation after the onset of the financial crisis. At this point, it is clear from the FSA, CFTC, and DoJ documents, Barclays, which may well have been in the front of the pack in relation to rate-fixing before the crisis, was now being dragged along reluctantly. But given that interbank lending on longer maturities had essentially dried up, LIBOR submissions were in any case close to surreal. And it may not have been at all unreasonable to be concerned both that submissions that gave an accurate picture might create a crisis of confidence – and that a bank which chose to be honest where others were telling flagrant lies might be committing suicide.
A key question is in which of these two kinds of fixing the extraordinarily large number of banks now being investigated belong. Insofar as it is the former, then this is evidence of pervasive corruption in the system prior to the financial crisis. Insofar as it is the latter, it is evidence that the problem of massive fragility – totally unanticipated by mainstream economists – could have been even more acute than we already knew. The crucial scandal then becomes how this extraordinary situation developed – and why nothing serious has been done to prevent a recurrence.
I have tried to say something not too stupid about some of these questions in a post on the Sic Semper Tyrannis blog run by Colonel W. Patrick Lang, former head of Middle East intelligence at the Defence Intelligence Agency. This has drawn extensively on your invaluable posts on these matters. I hope I have given adequate acknowledgement!
The post is at http://turcopolier.typepad.com/sic_semper_tyrannis/2012/07/habakkuk-on-the-libor-scandal.html
DH, Isn’t it ALL about leverage to profit insiders with access for manipulation in order to bring short-term outcomes repeatedly, ad infinitum?
Must run in the family.
His brother Raj, a psychiatrist and TV celebrity/popularizer, was done for plagiarism in 2008, and “struck off” by the UK’s General Medical Council for three months for dishonesty (that is, deemed effectively too dishonest to practise his profession):
http://www.guardian.co.uk/lifeandstyle/2008/oct/24/raj-persaud-psychiatry-maudsley
Now, if only there was an equivalent body for “striking off” dishonest economists!
But how do you know that the submission of 1.0 (in the example) is wrong? “banks submit a figure that is supposed to represent their cost of borrowing/lending at various maturities in various currencies.” So how does anyone outside of e bank know that any particular submission is wrong or right?