Monday, 9 July 2012

Guest post by Arthur Doohan: The facts about LIBOR

Arthur Doohan: Personally, I love a good conspiracy theory even though most of them can’t take a rinse let alone a serious ‘spin-cycle’. But matters take on a different colour when the conspiracy theory feeds a hysteria that turns people into a lynch mob.

Much of the nonsense currently in the air about ‘LIBOR’ and attempts to manipulate it for personal gain is destructive, dangerous and will leave everyone feeling foolish and looking incompetent, which, no doubt, many are but it does neither them nor us much good to have the mask of dispassionate professionalism slip so far and reveal so much.

Let us start with a few facts and inconvenient truths.

The British Bankers Association which runs the ‘LIBOR fixings’ system is a private trade representation or lobby group. ‘LIBOR’ is not part of any legislatively enacted or governmentally sponsored program. ‘LIBOR’ is a bankers convention, created by bankers for their own and their counterparties convenience. ‘EurIBOR’ is the same thing but run by the European Bankers Federation. Both systems are operated by the so far un-impeached agency of Thomson-Reuters on behalf the sponsors. If someone created a better one (and several have tried) the world and its market-makers are free to move to it. It is a banker’s shorthand that for decades was a core component of the transparency and efficiency that made London such a global financial centre. It predates derivatives all types apart from options....

I do not seek to defend bankers or their practices. I personally left investment bank trading because I found it to be morally corrosive and no longer wished to be a ‘professional gambler with other people’s money’. But we are not going understand the mess we are in with ‘universal banking’ and hyper-liquid trading of assets, real or imaginary (sorry, that should be ‘derived’...) unless we ascertain the facts. As a former ‘LIBOR submitter’ and derivatives trader there are a few facts that need emphasising. Otherwise, the authorities and politicians will once again be in error as to the real problem and, as usual, with mis-diagnoses end up prescribing the wrong treatments.

Here’s another inconvenient truth.

It has not been proven that any submissions by Barclays to the BBA LIBOR panel have materially influenced the setting of a single rate on a single day to the demonstrable cost of any borrower or derivative counterparty.

Read that again.

It has not been proven that any submissions by Barclays to the BBA LIBOR panel have materially influenced the setting of a single rate on a single day to the demonstrable cost of any borrower or derivative counterparty.

Yes. That is the truth. I do not doubt that if they could have, the traders would have manipulated LIBOR for gain but it has not been shown that they did.

Here’s some others.

The FSA ‘final notice' to Barclays admits only that there was a ‘risk’ that the integrity of the ‘LIBOR’ settings would be compromised.

The fine is a number plucked from thin air and has no material basis of calculation against any putative gain arising from malfeasance on Barclay’s part because it would not be possible establish such a figure.

Some of the evidence is inconsistent, such as asking for submissions that were so skewed that they would not be included in the calculation. What evidence there is shows that submissions were ‘manipulated’ by the startling amount of 1 one-hundreth of a per cent. In one paragraph there is a request for a ‘low submission’ when the trader states that they are ‘long’ the asset class in question, which is nonsensical in that they are asking to have a lower return on something they have a lot of.

Some further facts to bear in mind.

These rates are for borrowings and derivatives only. They have no direct impact on deposit rates. Further, they have no direct impact on borrowing for mortgages, personal finance and small businesses which are set under different criteria and adjusted less frequently.

Lastly, given the commonly complained of reality that most derivative trading is a ‘casino’ indulged in by banks exclusively then for every ‘big boy’ with a ‘long position’ there must be another ‘big boy’ with the equivalent ‘short’ whose preference will be for the submissions and consequent settings to be the opposite way round.

This is why the system discounts the extremes and takes an average of the remainder.

There is a further long section of the ‘final notice’ that is concerned with Barclay’s behaviour during the ‘liquidity crunch’, the intense phase of the crisis when there was, in the FSA’s own words, ‘ a virtual standstill’ in the money markets, ie there was no market.

At a time when the markets were dysfunctional arising from over a decade’s worth of ‘light touch regulation’ the regulator now fines Barclays over the ‘truthiness’ of its quotes at a time when other regulators and authorities were in dialogue with Barclays for a percieved excess of ‘truthiness’ in those same quotes, which ‘truthiness’ was embarassing the authorities who wished to pretend to the electorate and populace that the crisis was less severe than it actually was.

The FSA did fine Barclays for breaches of FSA rules with respect to Barclays internal procedures in the conduct of FSA regulated business and it is entitled to do so. I don’t approve of trader’s trying to ‘game’ the system but that’s akin to complaining about cats catching mice.

Barclays suffered less trauma and imposed no burden on the taxpayer arising from the crisis and made an effort to be honest at a time when others were actively promoting fictions.

In simple English, you were being lied to by a bunch of banks about the seriousness of the crisis and the authorities are now seeking to punish them for a ‘story’ the authorities took an active hand in promoting and managing and they have started this ‘show trial’ with the bank that told the smallest lies.

There have been misjudgements aplenty by all concerned; Barclays, BoE, FSA, other banks, media and lots of people wanting to blame bankers for all our problems.

I don’t understand why Barclays did not resist this penalty more vigourously. I suspect that they wanted the annoying pompous gnat of the FSA to go away, that they wanted to subscribe to and support the fiction that FSA and other regulators are ‘in charge’ and that the cost would be less to them than to the other more guilty parties, whose fines and ‘final notices’ will be made public shortly.

I don’t think they or the authorities anticipated the degree of public reaction to this story. The fact that Barclays admitted the facts and collaborated with authorities meant that their story came out first and made them the public focus. Getting a ‘rebate’ on the fine only incensed the public further as opposed to the probable intent of rewarding Barclays and promoting them for ‘good citizenship’.

True to form, once the politicians saw the ‘mob’ forming, they egged them on rather than trying to stand up for generality, due process and principle.

The eggs are still flying....there’s going to be a hell of a mess, especially on the politicians faces.

Just remember this.

No one has shown that any class of citizen or consumer has suffered a material loss from the least egregious attempts at manipulating a purely private ‘contraption’ that forms a part of the ‘plumbing’ of the financial ‘casino’ at a time when the ‘casino’ was broken and all the ‘players’ were doing the same thing.

Finally, ‘LIBOR’ is a child of an information poor age. In a time before computers and when global communications were expensive and when banking and finance were a less central and fascinating business, a ‘shorthand’ was required in order to ‘benchmark’ loans. That the system was trusted for so long is a testament to its simple elegance. But in an age of ‘big data’ and cheap communications and financial crisis organising a robust, verifiable and real LIBOR should be a trivial exercise.

I suggest we focus on making the system work for the equal benefit of all rather fixing the blame, of which there is plenty to go around.

Arthur Doohan is a former banker currently promoting a public policy debate on alternative solutions to the debt crisis in Ireland and to bank restructuring.


Matthew Platte said...

Too many strawmen. Here's just one example: "...people wanting to blame bankers for all our problems."

No, people are wanting to blame bankers for, you know, actual and suspected fraud. Criminal investigations are required to "[show] that any class of citizen or consumer has suffered a material loss..." Criminal investigations are required to explore the cozy relationships between your (former) colleagues and "politicians".

But instead of calling for such investigations into the behaviour of your (former) colleagues you point your nose to the sky and say, "Tut-tut, dear; boys will be boys. Now run along and let us boys get back to our gang-banking."

Anonymous said...

This is a highly tendentious presentation of the case. Only a full investigation revealing all the banks actual borrowing costs and any discrepancy between those and the published LIBOR (and other) rates would reveal the degree of market-rigging. Who then lost by this is a separate and larger matter. No doubt US lawyers are on the case currently.

But the idea that this was of no importance and not done for profit is not supported by the facts. The FSA says, in terms, that Barclays derivatives' traders manipulated the rates for their profit.

And here's what the traders themselves said of the '1bps change' "I need a really low 3M fixing on Monday- preferably we get kicked out. We have about 80 yards (billions) fixing for the desk so every 0.1 lower in the fix is a huge help for us".

0.01% of 80 billion is 8 million. As its 3Month money the net gain is 2million. This is additional profit made by this desk for this one trade alone.

Public policy debtate needs to begin with the facts, not an apologia.

Michael Burke said...

Apologies, above comment was mine.

artied said...
This comment has been removed by the author.
artied said...

@ Matthew Platte
If there was sufficient evidence for a criminal investigation then it would already be in the hands of the DPP and the FSA would have withheld their report & fine so as to avoid any chance of prejudicing a trial. Nor would the PM and other authorities have been so quick to comment.

I do not suggest that business as usual should be tolerated. There is nothing of the sort in that blogpost. I do think that going after scapegoats allows people to be sidetracked from pursuing serious reform way beyond what the watery and delayed Vicker IBC offered.

The FSA has bungled the PR on this and the 'Old Lady' panicked and pushed BDiamond onto a his sword to save any further fuss….so now the matter will be considered dealt with….while the root of the problem remains unchanged….

@ Michael Burke
I don't say its not important; I say it is not proven. Your cited quote suggests the confusion and difficulty of proving it; if they quote badly they have no effect.

I want all the facts and serious change; not some hysterical scapegoating and revolving door for apparatchiks….