The Latest Victim of the Credit Crunch: Libor

Carrick Mollenkamp has a worrying piece in the WSJ today about Libor in general, and the much-benchmarked three-month Libor fixing in particular.

Jitters have made many banks unwilling to extend loans to each other for more than one week. As a result, the rates they quote for loans of three months or more are often speculative, because there's little to no actual lending for that time period, brokers say. "It amounts to an average best guess," says Don Smith, an economist at ICAP, the London broker of interbank loans and derivatives.

This is a genuine and big problem, and one can see how Yves Smith could slip gently into hyperbole in response:

I saw this when working briefly in Mexico in 1984. The local McKinsey office confirmed that there was no reliable data in the entire economy.

It's not that bad, at all. For one thing, as the article points out, it's not in banks' best interest to underreport the rates they're paying on interbank loans, since their own assets are largely tied to Libor. If you're earning understated Libor plus 20bp, while in reality you're paying understated Libor plus 30bp, then you're in deep trouble.

But it is peculiar, to say the least, that unsecured debt is seemingly being marked at lower rates than secured debt:

The Federal Reserve recently auctioned off $50 billion in one-month loans to banks for an average annualized interest rate of 2.82% -- 0.1 percentage point higher than the comparable Libor rate. Because banks put up securities as collateral for the Fed loans, they should get them for a lower rate than Libor, which is riskier because it involves no collateral.

There's no easy solution to this problem, beyond looking only at the more reliable Libor fixings, such as the overnight and one-week rates. But with many loans tied to one-month and three-month Libor, that won't help a great deal.

Update: The British Bankers' Association now says it will ban anybody deliberately misquoting interbank rates.

Comments

[orca:]

Good post. I thought exactly the same thing as the McKinsey 1984 people when I read the Bloomberg article this afternoon. There is another point to make, and that is that LIBOR is LIBOR, ie that what banks charge each other IS LIBOR. It seams that every single institution is paying LIBOR +, so clearly LIBOR is manipulated. There used to be a few reliable indicators, but one by one (Baltic Dry also f***ed up) they are history. The few remaining indicators are too big to manipulate, being in my humble opinion the USD, Gold and Crude. Very sad that the UK/USA are clearly using a French/Zimbabwean method, in falsificating data and creating continuing moral hazard.
Kind regards,
Orca, Belgium

2008 Apr 16 01:07 PM

[User 86945:]

Hey Orca,

How is the Baltic Dry Index F***ed up?

2008 Apr 16 04:52 PM

[orca:]

Baltic Dry Index data has been corrupted by Hedge Funds buying capacity in anticipation of demand. This is not a secret, however, BDI was supposed to be a "pure" index, measuring actual demand in RT, not some forwardhedging proxy for commodities. That is why BDI is not anymore a valid indicator of shipping activity / demand.

2008 Apr 17 01:44 PM

[alex s:]

Why are you in deeper trouble when you're charging understated libor +20 and paying understated libor +30? the spread is the same, its not as if lying about libor changes one side of the equation. please explain the logic

2008 Apr 17 03:10 PM

[orca:]

Alex, the point is that by understating LIBOR you are corrupting data on all other rates, from mortgage to bizniz to whatever have you. It has a cascade effect on everything, but most of all it undermines trust. Trust is what is needed, especially now and especially in the financial sector, and this shows that they are still playing games. It is the rate equivalent of level-3 marking to fantasy.

2008 Apr 18 10:15 AM