
Is LIBOR, Benchmark for Trillions of Dollars in Transactions, a Lie? - signor_bosco
http://www.rollingstone.com/politics/news/taibbi-is-libor-crucial-financial-benchmark-a-lie-w497305
======
smallnamespace
This is old news for large portions of the interest rate derivatives market,
which is quickly moving towards OIS[1] rates instead, based on widely traded
liquid instruments.

Also, the implication that LIBOR is purposefully a scam is basically untrue.

When LIBOR was first developed, it was an improvement on other interest rate
benchmarks, and it also reflected current market conditions at the time, as
banks actually did regularly make bilateral interbank (the 'IB' in LIBOR)
loans to one another.

There are checks built into LIBOR to discourage fraud: for example, the actual
calculation discards the high and low outliers, so individual banks cannot
manipulate the benchmark easily[2].

But as the interest rate market continued developing, much of the actual
lending transaction volume moved towards other markets; the financial crisis
just accelerated that trend.

So now we have a lot of contracts written against a benchmark that slowly
stopped reflecting an actual interest rate market. The right path forward
would probably be to renegotiate these contracts so that going foward, they're
against OIS instead.

[1]
[https://en.wikipedia.org/wiki/Overnight_indexed_swap](https://en.wikipedia.org/wiki/Overnight_indexed_swap)
[2]
[https://en.wikipedia.org/wiki/Libor#Calculation](https://en.wikipedia.org/wiki/Libor#Calculation)

~~~
lomnakkus
Just by your terminology, I trust that you know (at least somewhat) what
you're talking about, so... is there an ELI5 for this stuff? I'm completely
lost in these types of discussions. They seem absurdly complicated for
(good|bad) reasons? Are we looking at another complexity bubble that's going
to burst in 5-10 years... to the detriment of everyone but the "top execs"
who'll be bailed out?

My impression after reading "Too Big To Fail" \-- which, BTW is an amazingly
well-written book[1] -- is that "they" will probably get away with all this
confusion and obfuscation... right?

I really do want to learn at least a little bit, but it seems like such an
impenetrable world of concepts, and I really do want to avoid the "news-based"
or even "journalist-based" approach to learning about this subculture. (When a
Dartboard fares better that your average journalist/investor-proxy, you know
you have a gambling problem.)

[1] Not sure how _accurate_ it is, but it's really well-written and exciting.
Unfortunately, it doesn't delve that much into the technical concepts in
Finance :(, though it does mention LIBOR at least once.

~~~
jpttsn
Good reasons, imho. The complexity is not (purely) a smoke screen thrown by
conspiratorial insiders.

Most of the harder tech HN articles would seem just as impenetrable to regular
Bloomberg Terminal users.

~~~
freeflight
The difference being that in tech the complexity just happens as a byproduct.

With the "finance industry" the complexity is not a bug, it's a feature, to
keep ahead of regulators. Every time some immensely profitable "market" gets
regulated the "finance industry" does it best to create a new "financial
vehicle" to feed that unhinged greed for the fictional perpetual economic and
financial growth.

It's an endless cat&mouse game that has been going on way too long and got us
into this current messy situation where the "finance industry" might just as
well be considered a fantasy football league, completely decoupled from the
actual day to day realities of the vast majority of human beings, yet still
holding massive influence over their futures.

~~~
jpttsn
I disagree; I think that's just a lazy way to look at an unfamiliar field.

Likewise, plenty of clueless non-techies suspect techies are intentionally
making tech seem complicated. Why can't Apple make a back door for the FBI and
nobody else?

------
lordnacho
Pretty much everything that has derivatives tied to it is manipulated. Option
expiries, FX fixes as well. Or it was when I was looking at it.

The thing is there are derivatives that are sometimes non-linear, things with
triggers and barriers. When some large enough fish has one of these (eg by
taking the other side vs a customer) they have an incentive to move the rate
in whatever way they can. Whether it's getting someone to submit a bad rate or
sitting on an FX cross, it can be worth it.

Before I went full quant I was often looking at the screens manually. You'd
often see at around the WM/Reuters fix that the price would move strangely. An
unusually large move would happen with no apparent news. You'd get a rumour
from a broker, but who knew how they knew? And quite often the move would fade
after the window closed.

This would happen even in exchange traded options. If you knew the specifics
of the settlement window, you would know when the price would go wonky. You
wouldn't know who, but you knew that is wasn't a normal time in the market.

The LIBOR was a bit less obvious, only really clear to me in hindsight. Swaps
don't have a common schedule like listed options, so there's a fixing every
day that could be in someone's interest to influence. Same goes for FX, but
since LIBOR is a bunch of opinions (as opposed to trades) it's not as obvious.

~~~
JumpCrisscross
> _This would happen even in exchange traded options. If you knew the
> specifics of the settlement window, you would know when the price would go
> wonky._

Exchange-traded options settle on a predictable window; there's no "if you
knew" to it [1]. Also, the price goes wonky near expiries because that's when
delta approaches one. Market makers switch from hedging with derivatives to
hedging with spot; that means jitters.

Not saying there's no fraud. But pricing going wonky around a settlement event
makes sense as everyone prepares for it.

[1] [http://www.dtcc.com/~/media/Files/Downloads/legal/service-
gu...](http://www.dtcc.com/~/media/Files/Downloads/legal/service-
guides/Settlement.pdf)

~~~
coliveira
Your understanding of the market doesn't consider that there are big players
who overshadow everyone else. Yes, everybody prepares for the expiration of an
option, but very few players can do anything to influence prices. Only a
handful of institutions can successfully trade around these expiries, which is
what the commenter above is mentioning.

------
Afforess
This article contains a rather poor explanation of what LIBOR is and the
history around it. Matt Levine does a much better job:
[https://www.bloomberg.com/view/articles/2017-07-27/the-
end-o...](https://www.bloomberg.com/view/articles/2017-07-27/the-end-of-libor-
and-non-voting-stock)

 _Back in the 1960s, a Greek banker in London[1] wanted to find a way for
banks to make syndicated floating-rate loans. He found a very simple answer:
The banks would lend money to a company, charging their cost of funds plus a
spread, and every three months, you 'd go out and ask the banks what their
cost of funds was, and you'd average their answers, and that (plus the fixed
spread) would be the new interest rate on the loan. This was a simple product
for the banks: They could pass their costs on directly to the customer, and
make a fixed profit (the spread). And by surveying all the big banks and
throwing out outlier submissions, you could get a pretty fair approximation of
the overall funding cost for banks._

 _And so this -- Libor, the London interbank offered rate -- became the normal
way that everyone did floating-rate loans, and then it became the normal way
that everyone did interest-rate derivatives, and then it became the normal way
that everyone did ... sort of ... everything? Libor just sort of became The
Interest Rate, used for discounting cash flows in all sorts of transactions,
"the most important number in the world." But it was always based on a survey
of banks' funding costs, and so it was always a little hazy. One problem was
that the banks could lie. But a second problem is that the banks might not
even know. Libor surveys asked banks each day what they would have to pay to
borrow money unsecured from other big banks, but over time the banks sort of
stopped doing that, particularly in some of the more obscure combinations of
tenors and currencies that nonetheless reported Libor rates. So the banks'
Libor submitters would guesstimate their submissions based on deposit rates
and commercial-paper rates and secured-borrowing rates and other tenors and
what brokers and their buddies were telling them. It was all more or less good
enough as a casual system for resetting the rates on a few billion dollars
worth of syndicated loans, but it was not accurate down to the hundredth of a
basis point as a foundation for the financial system, or as the source for
pricing hundreds of trillions of dollars of derivatives._

[1] Minos Zombanakis: [https://www.bloomberg.com/news/features/2016-11-29/the-
man-w...](https://www.bloomberg.com/news/features/2016-11-29/the-man-who-
invented-libor-iw3fpmed)

~~~
tptacek
Matt Levine is so much better on these topics than Matt Taibbi that one might
hope the site would switch URLs. But, of course, accuracy is not the reason
people read Taibbi's financial reporting. They're both humorous writers
(though in different ways; Taibbi is the better of the two as stylists), but
Taibbi is also emotionally satisfying.

It would be helpful if people kept providing Levine pieces to accompany Taibbi
pieces.

~~~
al452
In some ways agree, except that I do not find Taibbi's rage-driven ignorance-
fuelled style in any way "emotionally satisfying".

------
NelsonMinar
Taibbi's gonzo style is amusing shtick, but frequently exaggerates. If you'd
rather read a boring but reliable Economist take on the same story:
[https://www.economist.com/news/finance-and-
economics/2172581...](https://www.economist.com/news/finance-and-
economics/21725811-regulators-are-nudging-financial-markets-towards-new-
reference-points-crucial)

The facts are more or less the same in both stories.

------
Torai
_It later came out that banks had not only lied about their numbers during the
crisis to make the financial system look safer, but had been doing it
generally just to rip people off, pushing the number to and fro to help their
other bets pay off.

Written exchanges between bank employees revealed hilariously monstrous
activity, with traders promising champagne and sushi and even sex to LIBOR
submitters if they fudged numbers.

"It's just amazing how LIBOR fixing can make you that much money!" one trader
gushed. In writing._

Maybe this is old news, but they should be imprisoned for it.

~~~
bboreham
Some have been jailed. Jay Merchant, Tom Hayes, etc.

------
zzalpha
For folks who feel like they knew about this story already: read the article.

LIBOR fixing is one thing. But the realization that _there is no market that
LIBOR measures_ is truly astonishing!

2021 will be an interesting year...

~~~
JumpCrisscross
> _there is no market that LIBOR measures_

Except that's not true. Interbank lending is still a $70 billion market in the
United States alone [1]. Small compared to banks' balance sheets and less than
the $500 billion from as recently as February 2008, but material nonetheless.

Good rule of thumb in finance is to ignore Matt Taibbi.

[1]
[https://fred.stlouisfed.org/series/IBLACBM027NBOG](https://fred.stlouisfed.org/series/IBLACBM027NBOG)

~~~
jkaptur
I'm not a domain expert, but both could be right - isn't the point that some
currencies and tenors are very illiquid, not that the entire market doesn't
exist?

~~~
JumpCrisscross
> _isn 't the point that some currencies and tenors are very illiquid_

Yes. It's a subtlety bulldozed over in this article because nuance doesn't
sell clicks like outrage. Recapitulating an earlier comment, the regulator
Taibbi cites speaks competently about this [1]; the _least_ actively-traded
currency-tenor traded only about once a month. (Every other currency-tenor
traded more often.)

That may be a fine frequency for 6-month wholesale interbank rates in Danish
krona (which, until recent reforms, was one of the currencies Libor was quoted
for [2]). But turning it into a daily rate with three decimal places of
precision is silly.

[1] [https://www.fca.org.uk/news/speeches/the-future-of-
libor](https://www.fca.org.uk/news/speeches/the-future-of-libor)

[2]
[https://en.wikipedia.org/wiki/Libor#Currency](https://en.wikipedia.org/wiki/Libor#Currency)

------
ojosilva
The Euribor, which governs my mortgage, uses the same interbank lending
sources as the LIBOR.

[http://www.euribor-rates.eu/what-is-euribor.asp](http://www.euribor-
rates.eu/what-is-euribor.asp)

But I can't say I'm unhappy with it: never have I paid so little interest on
anything I've ever owed, Euribor is negative right now and I'm loving it.

Whatever means of calculation or manipulation are being used, they are working
out in my favor today. Maybe a stricter regulation would limit the banks
abilities to lend competitively, which may not be in neither their, mine nor
the government's favor.

------
heisenbit
> But beginning in the mid-nineties, banks began to discover that other
> markets provided easier and cheaper sources of funding, like the commercial
> paper or treasury repurchase markets. Trading between banks fell off.

The continuous easy money policies have prevented the markets to price credit
risks for a long time. This has manifested itself in a series of bubbles.
Weaning off will be difficult. Not weaning off will ensure collision with a
brick wall eventually.

------
pjdorrell
Surely some borrowers and lenders make decisions about making and taking loans
based on the actual interest rates on the actual loans? In which case it
doesn't matter so much if the rates are calculated based on a fictional
assumption about something. At the end of the day every borrower or lender in
the market makes their own decision about which lending contracts they take
part in.

------
cperciva
On the one hand, LIBOR is a completely made-up number. On the other hand, so
are central bank rates.

If you're going to peg transactions to a made-up number, is LIBOR really any
worse than anything else?

~~~
bboreham
Central banks actually will lend (or take deposits) at their rate. So in that
sense it's not made-up.

~~~
coliveira
Does it matter? Central banks are creating money, so of course they can pay
the interest rates they made up from whole cloth.

~~~
bboreham
My point was, if you can act on the number quoted, then market forces will
eventually move it back into line with reality.

And history teaches that there is eventually an end to governments' ability to
print unrealistic amounts of money. See Zimbabwe, the Weimar Republic, etc.

~~~
coliveira
In this case the market forces act only when the projections are too
unrealistic compared to the size of the economy. Small variations in rates of
less than a percentage point will not doom an economy in the medium term, but
certainly can make a huge fortune for people involved in the manipulation.
This is the case in all western economies.

~~~
bboreham
I'm not sure what you're talking about now. There are no market forces acting
on _projections_ : that's my point.

EDIT: and LIBOR isn't much of a projection, it is "I believe I could borrow at
this rate, today, if I needed to"

~~~
coliveira
I am talking about projections of growth and their relationship to interest
rates. Interest rates have to be paid based on future earnings, but
projections for future earnings have always a big variance. Therefore, small
changes in interest rate have little meaning in terms of capacity of
repayment, but have great meaning in term of money made by banks (or in terms
of policy, by central banks). That's why it is so easy to manipulate interest
rates within certain limits, contrary to what you said about resulting
inflation.

------
xefer
There are so many bilateral derivative contracts tied to LIBOR what would it
even mean for this benchmark to go away?

~~~
cm2187
I don't think it will completely go away. It will be replaced by some other
benchmark calculated differently. Derivatives won't be a problem as the ISDA
association can make a decision that would automatically convert all
contracts. Bonds and private contracts will be more of a problem as they don't
necessarily have a language for what happens if the index stops being
published.

------
veritas213
it wasn't till it became.

There was clear evidence of fraud and broken fiduciary responsibilities which
i belive are unforgivable.

LIBOR will still be around but its importance will diminish in perpetuity.

------
rbanffy
Isn't the value of money a lie we all agree is true?

------
Spooky23
Markets need transparency and trust to be effective.

------
dogruck
Ah, Rolling Stone -- great source for solid info on LIBOR.

~~~
65827
Are you dense? Matt Taibbi is possibly the most informed and important
financial journalist of the last several decades.

~~~
dogruck
Thanks for the insult.

Matt Taibbi has an unabashed, heavily liberal bias. He sells by appealing to
readers like you.

I would argue that Michael Lewis is a superior popular finance writer.

~~~
MichaelBurge
What stops your criticism from being a fully general counterargument against
any community with an opinion?

The EFF is biased in favor of free speech and encryption, and markets to
cyber-punk programmers. So all arguments in favor of free speech made by any
EFF member in any EFF-related article can be immediately discarded.

"dogruck on HN" is biased against rollingstone.com; and gathers upvotes by
appealing to people who dislike rollingstone.com(which, separately, is
ineffective); so we should discard his opinions.

In fact, because you seem to know about biases, you may actually be more prone
to them:
[http://lesswrong.com/lw/he/knowing_about_biases_can_hurt_peo...](http://lesswrong.com/lw/he/knowing_about_biases_can_hurt_people/)

~~~
dogruck
What is wrong with being skeptical of a publisher or source? Surely you don't
claim that every source is equally valid.

In fact, my original post, which expressed dismay that we celebrate Rolling
Stone for reporting about LIBOR, has been downvoted 4 times.

~~~
jmanderley
If you want to be lauded for "being skeptical", maybe include some kind of
interesting or informed commentary or critique instead of posting a
meaningless drive-by attack on the source.

------
osrec
Libor is clearly out of date and open to manipulation (as are a lot of
measures in finance). It's funny how so much of finance is quite literally
opinion, presented as a number attempting to masquerade as fact. Every stock
price, every swap rate, every credit rating. They're just herded opinions,
often churned out of poor quality models or unstable, easily manipulated
processes! As for making libor up, in my opinion, it was pretty made up, even
if it's original processes worked as expected. You see, it assumes integrity
on behalf of it's contributors, and that assumption is utterly false; every
bank has an ulterior motive to optimise in favour of its portfolio. Finance in
general needs a rethink; it's full of obvious moral hazard, which has somehow
been considered acceptable through the times. The interest rate markets are
probably a good place to start shaking things up, as they are likely full of
the biggest manipulations.

