Counterparties: How to fix libor

September 28, 2012

Welcome to the Counterparties email. The sign-up page is here, it’s just a matter of checking a box if you’re already registered on the Reuters website. Send suggestions, story tips and complaints to

The Wheatley Review is out. No, that’s not an obscure literary magazine – it’s a British regulator’s proposal to overhaul Libor, everyone’s favorite manipulated benchmark interest rate. In June, Barclays agreed to pay a $470 million fine for manipulating Libor.

Libor is calculated daily based on banks’ own reporting of their borrowing costs, which, of course, left it open for manipulation. If banks report high borrowing costs, the markets can get spooked and think they’re in trouble; report artificially low borrowing costs, like Barclays did, and your traders could make millions.

Enter Martin Wheatley, who’s the managing director of the UK’s Financial Services Authority and wants to push “the reset button on Libor”. The new Libor will no longer be overseen by the inherently conflicted British Bankers’ Association. Say goodbye, in other words, to that secret Libor committee of bankers meeting in undisclosed locations. Manipulating Libor will now also be a criminal offense, and Libor will be simplified to 20 rates from 150. Also, Libor will be more closely tied to real lending transactions whenever possible.

All of this seems perfectly sensible and drew praise from Bloomberg and Breakingviews’ George Hay. Simone Foxman likes the proposal because it restores Libor to its original state of a “high-brow measure of interbank lending”. To Matt Levine, who’s done terrific work on the subject, the guidelines for what counts as a real transaction are vague enough that it’s still a matter of “ehhh, figure out the right Libor and write it down.” But Wheatley does get the incentives right:

The Wheatley Review doesn’t blow up the $300 trillion of contracts referencing Libor; it just gently nudges banks away from them. Now they know that judgment-based Libors will be subject to a lot of scrutiny and criminal penalties, so they have every incentive to come up with a better system that avoids jail risk for them – but that also is efficient and trustworthy enough for the market to adopt.
Levine thinks the market (read: bankers) are the best group to come up with the correct Libor numbers. Floyd Norris, on the other hand, is skeptical: Banks are still submitting unrealistic bids, he writes, citing CFTC Chairman Gary Gensler’s recent testimony. Norris argues that Libor should be replaced with a “real” interest rate, something like the Fed’s overnight index swap rate.

In theory, that would prevent traders from chuckling over instant messages like “Nice libor“. — Ryan McCarthy

And on to today’s links:

Data Points
Since 1990, China’s GDP has quadrupled, but happiness hasn’t increased – NYT

Apple CEO to customers: “We are extremely sorry” – All Things D

Bad Data
Drug companies routinely withhold trial data when it hurts their bottom line – Guardian

Meet the world’s worst central banker – Atlantic

China’s economic slowdown is taking a brutal toll on Appalachian coal mining towns – WSJ

Upward economic mobility is increasingly uncommon unless you are born “with wealth or particular talents” – National Journal

Crisis Retro
BofA just paid $2.43 billion to settle charges it hid losses at Merrill Lynch – DealBook
How BofA execs hid their losses – in their own words – ProPublica
BofA has paid $29 billion in settlement costs since 2009 – WSJ

College students launch hedge fund with incomprehensible market-babble strategy – Hedgeco

Dept Of Sanitation
Treat banks like restaurants – and tell us where the rats are – Jonathan Weil

“Isn’t it glorious when editors stand up and take some blame?” – WaPo

Jeff Gundlach’s art has been found “at an automobile stereo shop in Pasadena” – LAT

New York: stuck with 1980s MetroCard technology – Capital New York

Primary Sources
Stress tests show Spanish banks are undercapitalized by 59.3 billion euros – Oliver Wyman

The Postal Service is defaulting (again) because the House won’t act – WSJ

Tax Arcana
France is launching a 75% tax on millionaires – Quartz

Stuff We’re Not Linking To
The benefits of a more vigorously vibrating iPhone – Atlantic Wire


Comments are closed.