« The European 'Saving' Programs | Main | The Dead SOFA »October 13, 2008 LIBOR ManipulationAbout $300 trillion of contracts world wide are anchored to the London Interbank Offered Rate (LIBOR) interest rate. A higher LIBOR means higher interest rates for many, many people. Interest rates of many mortgages, commercial papers and municipal loans are bound to LIBOR rates. LIBOR is the reported or guesstimated interest rate of loans big banks make to each other. As all banks can now borrow at very cheap central bank rates in practically unlimited amounts real interbank lending ceased to exist. There are now lots of international initiatives to revive interbank lending which will all fail as long as central banks like the Fed keep up their current policy of unlimited lending against collateral of very dubious quality for very low rates. Meanwhile the private banks involved in determining the daily LIBOR rates will report their estimation of such rates and the average will be published as that days LIBOR rate. This directly influences the credit conditions for the real economy. Variable interest rates on credit card loans, adjustable mortgages to home owners, revolving credits to producing companies are contractually bound to interest rates at LIBOR+X. But the real LIBOR of interbank lending does not exist anymore if interbank lending, like now, has been replaced by unlimited lending from central banks to private financial institutions. The London Review of Books recently had a decent piece on how LIBOR is in fact determined. It solely depends on input from private banks and that does not necessarily mean on input of their real lending conditions: Note the conditional: a Libor input is what a bank could do, not what it has done. So judgment is involved. A bank might not have borrowed anything in the minutes before 11 a.m.
A bank might have borrowed cheap from the Fed, but not from it peers. So it might report an estimate to LIBOR that is much higher than the real interest rate it pays actually is. This is a racket. Borrow cheap at the Fed window, report high fantasy interbank lending rates to LIBOR and pocket the difference from the commercials who have to borrow from you at LIBOR+X. In comments Sustain26 pointed to a paper (pdf) that suspects such manipulation. Yves at Naked Capitalism recently put up a chart that shows how the rates reported from various banks for LIBOR suddenly vary extraordinary. While usually the banks reported rates for interbank lending that differed by 0.02% in interest, they now report rates that differ by of up to 1.75%. It is obvious that some of the banks are trying to manipulate LIBOR up. In consequence the real economy will suffers from too high LIBOR+X interest rates and the banks will reap profits on huge margins between Fed rates and fictional LIBOR+X rates. There are two ways to solve this: a. Stop making cheap central bank loans available to banks and let real interbank lending revive to determine a realistic LIBOR. b. Legislate to convert all LIBOR+X rates contracts to Fed-rate+Y contracts. If this is not done immediately, the banks will suffocate the real economy to enrich their owners and management. Posted by b on October 13, 2008 at 03:18 PM | Permalink http://mrmortgage.typepad.com/blog/2008/04/libor-manipulat.html |
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