Wednesday, July 25, 2012

FSA's Lord Turner: Libor now honest

As reported by Reuters, the head of the UK's FSA, Lord Turner, is saying that Libor is now honest and that replacing Libor interest rates would be problematic.

It is great that Libor is currently being reported honestly.  To ensure that it is always reported honestly a couple of changes need to be made.

First, banks on the Libor panel must be required to disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details.  Market participants, particularly the banks with deposits to lend, can use this information to assess the risk of each bank on the panel.

To make it easy for market participants to access the exposure details, they should be collected, standardized and disseminated by the "Mother of All Financial Databases".  This is a data warehouse coordinated and overseen by a conflict of interest free independent third party focused on optimizing transparency in the financial system.

This ability to assess the risk of each bank on the panel will unfreeze the interbank lending market and keep it functioning in the future.

Second, Libor should be based off of actual trades by the bank panel members.  For those maturities or currencies where there are not trades, there are a variety of ways to estimate what the interest rate would be if there had been any trades.

Dishonesty uncovered in setting Libor benchmark interest rates is now in the past and replacing them would be problematic, the head of Financial Services Authority said on Tuesday. 
The discovery that bankers rigged the global rates determining the value of assets worth more than $500 trillion has put regulators under fire for failing to spot the problem in 2008 and set off a debate over whether the system should be replaced. 
"I think it has been pretty robust since 2009 and 2010," FSA Chairman Adair Turner told a Bloomberg News event. "People are trying to do it as honestly as they can."... 
Turner said that since early 2011, banks have had to attest to the quality of their Libor submission process to the regulator. 
"I would be very amazed if at the moment there is anything remotely like the problems of the past in terms of deliberate manipulation," Turner said. 
Your humble blogger prefers that we move to a system where rigging Libor is not possible.  There is absolutely no reason to remain dependent on the honesty of people who have already shown a willingness to lie for profit and/or to enhance the market's perception of their financial strength and be amazed if they lie again.
In the distant past it would have been harder to spot manipulation of the benchmark interest rates, which originated in the 1960s, but any rigging would also have had a smaller impact, Turner said. 
At any point in time, had data on actual trades been disclosed to the market, it would have been easy to spot manipulation.
Because so many contracts were now linked to Libor estimates, it would create a major problem if there were an attempt to switch to a benchmark based on actual transactions, he said.
Therefore, Libor should be fixed.  The simple solution to fixing Libor is to require the banks to provide ultra transparency.

I am sure that the banks and their co-conspirators, the financial regulatory industry, will fight this.  The banks and the financial regulatory industry believe a series of one-off prescriptive regulations that protect opacity and are designed to try to mimic transparency is actually better than requiring transparency.

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