Monday, 10 April 2017

Libor Rates revisited

I watched the BBC Panorama tonight. As I have some acquaintance with the process I fill in some of the many gaps in the BBC's typically poor, shoddy journalism.

Libor rates c 2007 were set by the Britsh Bankers Association, the BBA. They were set or around 20 currencies, not just Sterling ove a range of tenors from overnight to 2 years. The most important were the one month and 3 month rate. The latter was used for swaps and option pricing world wide

Each currency had an associated panel of banks, around 16 for Stering. Every morning the BBA would phone all the panel members nd ask for their Libor rate ie the rate they would lend at in size to another bank on the panel. In size means circa £100 to £500 million. The BBA discarded the 4 top rates and the 4 bottom rates and calculated the average of the middle 8 rates which was published at 11:00 as the that day's Libor rate. It is therefore difficult to see how one bank could shift the rate significantly there had to be a group of banks involved, a comspircy.

In my work at the BoE I always distrusted LIBOR rates because they were not traded rates. I always used OIS , overnight interest rate swap rates which only the biggest 6 to 8 banks did and were trraded rates at which actual swap transactions took place.

I saw no evidence of rigging of the Libor market just a nagging uncertainty about the way LIBOR was compilied. It was open to manipulation.

All banks keep a giant spreadsheet that aggregates their net postions over all instruments, swaps, FRAs, options etc but they all settled against LIBOR so banks knew the precise effect of a one basis point move in LIBOR on their profits.


Thx to Austrianpeter for his comment. I should have pointed out that Libor is an unsecured rate and what you are detecting is the credit spread which can be very large to the point that you refuse to lend to some banks, called a credit crunch. Its not good to lend to counterparties you do not think can repay! Thats what happened to Northern Rock.

Banks can still borrow and lend on the GCRepo market where govenment bonds are pledged as collateral for the loan, All the BoE lending to commercial banks is done on this secured basis. Its been a legal requirement since 1848 ie before I was born. The problem is than to estimate the margin you need to take on the loan in case the collateral price falls. That hot potato always ended up in my lap in my BoE days. A  mistake would have been career terminating for those with BoE ambitions! I was often told I was expendable and had no BoE career. I was old even then.


Austrianpeter said...

Nice summary Doc. I too follow Libor 1 & 3 month rates as they are an early indication of stress in the system. I wonder what banks did before Excel came in - ? - pencil and paper I guess or was Borroughs (or NCR 32) accounting machines and punched cards? I guess you would know

Eric Edmond said...

I am old but not that old. If ypu look on the BBA website you may find when Libor was set up. Spreadsheets made it possible to game the effect of changes in Libor on your position.

The original spreadsheet was Visicalc written by a Harvard Yank, Dan Bricklin circa 1980. It had all you neeeded to do the Libor business but ran only the Apple II. It cost £150 and the City slickers were buyin Apple IIs at £1500 a throw by the shed load just to use Visicalc. It made a fortune for Apple then run by the Steve Wozniak who did the design and operating system and Steve Jobs who was the marketing guy. It was the first killer application the computer world had ever seen.

IBM then introduced Lotus 123 on their PC which added a few tweaks and made loads of money for IBM but their top management wer wedded to mainframes and never saw the potential of PCs. Jobs did!

Funnily enough I still prefer Visicalc. ts simpler and easier to use in my opnion but my APPLE II got scrapped 25 years ago. Sic transit gloria mundi.

Austrianpeter said...

Thanks for the potted history Doc. I was using an ICL 1900 in the early 70s and doing the old systems analysis work. Having migrated to DEC PD1134 and VAX it wasn't until 1981 that I met the Commodore Business Machine (CBM) the commercial version of PET and put them into our accountancy practice using CRACKER, a version of VisiCalc. I avoided Apple altogether and never ventured into Lotus 123, going straight to Excel.

Sorry if I took you back too far, but interesting that Apple got taken up by the City just to do their spreadsheet work. BTW Steve Jobs was originally at Xerox Park in the 70s, as you probably know. I was with Xerox then and using their Delta computer over the line with a GUI and mouse. Xerox always said they were a document company, not a computer coy, and let Steve go to develop Apple. Well that's the story at least we were told. When EtherNet arrived in 1978/9 we were told that Xerox would lead the way to a paperless office in less than 5 years! So much for predictions - it has ever been the case.

Great to chat, hope we might meet again with Niall sometime. Best regards Peter

Eric Edmond said...

Yes Xerox invented the whole mouse and Windows set up but Gates and Jobs made the money. Woz was a good programmer.