Friday, July 13, 2012

Geithner 2008 Libor memo shows Fed protecting opacity that allowed interest rate to be manipulated

In his 2008 email to the Bank of England's Mervyn King, current US Treasury Secretary and former head of the NY Fed Timothy Geithner manages to propose six solutions for addressing manipulation of the Libor interest rate and not one of his proposed solution would in fact end price fixing.  

That can only be accomplished by basing Libor on actual trades and requiring disclosure of all the trades at each bank.

As David Zervos at Jeffries & Co said and Mr. Geithner and the NY Fed were firmly aware,

It should come as no surprise to anyone that major commercial banks manipulate Libor submissions for their own benefit.

The OTC derivatives markets was designed by the big banks, for the big banks, to ensure that as they set up their own private securities exchanges - away from regulatory scrutiny - they could control the interest rate settings.

Money center commercial banks did not want the "truth" of market prices to determine their loan rates. Rather, they wanted an oligopolistically controlled subjective survey rate to be the basis for their lending businesses.

Please re-read the highlighted text as it nicely summarizes how Wall Street intentionally erects a veil of opacity so that it can manipulate the financial system for its benefit.

Given that Mr. Geithner and the NY Fed had reason to think that banks might not have been entirely honest when reporting their Libor submissions, there are a series of questions:
Why didn't he/the NY Fed recommend a transparency based solution to prevent manipulation of the Libor interest rate?
Why did he/the NY Fed recommend solutions that would not prevent an oligopoly from manipulating the Libor interest rate?
Mr. Geithner's and the NY Fed's Market and Research and Statistics Groups first suggestion (and people always lead with their best idea) for enhancing the credibility of Libor.
To improve the integrity and transparency of the rate-setting process, we recommend the BBA work with Libor panel banks to establish and publish best practices for calculating and reporting rates, including procedures designed to prevent accidental or deliberate misreporting.  The BBA could require that a reporting bank's internal and external auditors confirm adherence to these best practices and attest to the accuracy of banks' Libor rates.
To further enhance perceptions of the BBA as an objective intermediary in the rate-setting process, we recommend greater transparency with respect to the financial relationship between the BBA and the panel banks, and around the BBA's financial interest in Libor.
(for those who don't know, BBA is the British Bankers' Association and is a lobbying firm for the banks).

Compare and contrast to how a transparency based solution would be written.
To improve the integrity and transparency of the rate-setting process, we recommend that each Libor reporting bank disclose every funding related trade to a Libor data warehouse run by a conflict of interest free third party.  This data warehouse will determine the Libor interest rate.  Each reporting bank's internal and external auditors will attest to the accuracy of the reported trades.


Anonymous said...

i think i can answer your wonderings to some degree..

the question as to why the Fed didnt make a suggestion identical to one you have now written, 5 years later and in the light of further information, is a nonsense. aside from the different perspective, there are many ways it 'could' have been written, so why would you think yours is the 'right' one?

there are a number of other problems with your implications.

first, MK is the head of BoE. given that, even as the head of the NY Fed, TG has to treat such matters with some discretion.

second, the email is plainly a response to a conversation about the inherent vagueness of Libor, not about manipulation. it is therefore not necessarily making suggestions with respect to wrongdoing, but rather with confidence in the process generally, and its inherent procedural weaknesses. they include things which exist apart from intentional manipulation.

third, you are taking it as assumed that the idea of using real data can actually be done. the concept of a Fix is to collect data from a number of sources which pertain to a particular moment in time. do you really suppose that, at 11am, there actually IS actual data to report to anyone? that is across 15 maturites from a dozen banks. you can see for youself that TG specifically referred to the problem of lack of data for some tenors at all. if you envisage actual deal data, then over what time period? what if a bank didnt deal in that tenor or ccy on that day? so your suggestion is impossible in the current Libor framework. you are NOT talking about a Fix at all.

fourth, and related: this email is suggestions for improving Libor as it stands. you can see that from TG's initial words. why would he then go on to suggest the involvement of an as-yet non existent audited third party? even if TG thought that was a great idea, it is painfully obvious that such suggestion would have been beyond the scope of this email. you are proposing something completely differnt to the Libor fix.

seriously, you should be pleased that TG and the Fed, had enough nous to stick their nose in to a matter involving a different central bank in another country. i have NO doubt about who initiated the discussion in Basel. the complete inaction of the BoE makes that clear, and makes any discussion of why TG didnt suggest a completely novel replacement for Libor. ie there was no point anyway.

i think that should cover your questions.

Richard Field said...

First, thanks for answering the questions.

Second, the email that Mr. Geithner sent is an exercise in covering his backside and not an attempt to have any action taken.

We are talking about manipulating a benchmark interest rate for the banks' or individuals' at the banks benefit. We are talking about the persistent ethical failure of large banks.

The tone of the email is this is a minor technical problem. Mr. Geithner suggests there may or may not be some problem with the reporting.

At the time of his email, Mr. Geithner already knew since a Barclays trader had told the NY Fed that Barclays was manipulating its submissions. A fact that he might have wanted to share if his goal was to have Mr. King take action.

Third, we need to separate the technological feasibility of collecting the data from the issue of whether there is any data to collect.

Assuming there are trades, modern bank back offices capture this information as soon as possible after the trade. As a result, we are talking computers talking to computers. Hence, the proposed solution is technologically feasible.

As for the not every bank trades every maturity and currency every day, that is okay. Libor would be based off the trades that do occur for every maturity and currency. Basing Libor off a subset of banks is actually consistent with how Libor is currently calculated where it eliminates the banks with the high and low submissions.

But what happens when the interbank market freezes and no bank has any trades to report? This is actually valuable information for the market to have. The question is what should the Libor interest rate be when the market freezes?

Thanks again for your insightful comment.