Friday, July 20, 2012

Libor, Central Banks and the "Mother of All Financial Databases"

On May 22, 2008 the Bank of England circulated an internal document that suggests the it had some idea that Libor was being manipulated.
There is a long standing perception that Libor by virtue of the manner in which it is set is open to distortions:  panel banks have no obligations to trade or to have traded at the rates that they submit, so it is at least plausible that these are influenced by commercial incentives.
According to a Telegraph article (ZeroHedge has a must read piece on this article), a former RBS trader claims hedge funds routinely asked for Libor to be manipulated.  Here was the commercial incentive as the hedge funds were a major source of revenue to the traders.
He claims in his lawsuit that asking for changes in Libor was "common practice" among RBS traders and that the bank "took requests from clients" to alter the rate.
As the Libor scandal continues to grow, what is important to focus on is that we are talking about the integrity of the global financial system.

The question that must be answered is how to restore the integrity of the global financial system in a way that everyone would believe.

Your humble blogger realizes he has been talking about the need to bring transparency into all of the opaque corners of the financial system since the beginning of the financial crisis.  However, if this is not done, nobody will believe the system is not rigged and easily manipulated by the banks.

The Dodd-Frank Act was based on the idea that regulators had learned their lesson from the financial crisis and by giving them a second chance they would prove their worth.  Well, the Libor scandal shows this isn't true.


If the regulators had learned their lesson, they would have known that if you want to stop manipulation of a benchmark interest rate, you have to tell someone and stop using it yourself!

The Fed did neither.  What exactly was their excuse for not telling the Bank of England in 2010 that Barclays had understated its Libor submissions or telling the US public before the debate on Dodd-Frank?  Actually, nobody wants to hear their excuse.

We want the focus to be on how we can restore integrity and trust to the global financial system.

The only way that has been proven that can do this is by bringing transparency to all the opaque corners of the financial system.  This was successfully done in the 1930s.

In the 21st century, this means we should create the "Mother of all financial databases".  This database will be a repository accessible to all market participants (not like the Office of Financial Research which is only available to regulators and is the poster child for where transparency and trust in the financial system go to die).

At a minimum the database should have,
  • all the banks' exposure details on a borrower privacy protected basis.  The banks should be required to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details; and
  • all the current performance information on the collateral supporting structured finance securities.  This information should be reported on an observable event basis as activities like payments or default occur with the underlying collateral are reported before the beginning of the next business day.
This database should be overseen by an independent third party that is free of all conflicts of interest including who owns it, who is on its board, and who manages it.  We have seen in the structured finance market what happens when conflicted parties are involved in ownership and oversight of the data warehouse operating the database.

This independent third party's only business should be coordinating the database to maximize transparency in the global financial system now and into the future.

I fully expect that at their September 9th meeting, the leading central banks will endorse building the "Mother of all financial databases".  They know that restoring integrity and trust to the global financial system cannot wait.  

They also know that failing to endorse the building of the "Mother of all financial databases" is sending a signal that they are not unhappy with the current opaque, rigged financial system.

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