Thursday, January 10, 2013

Profitability of Deutsche Bank's 2008 bet could have been effected by manipulating Libor interest rates

The Wall Street Journal ran an article on Deutsche Bank's 2008 bet where the profitability of the trades could have been effected by manipulating Libor.

According to the whistleblower,

The documents from the former Deutsche Bank employee set out how traders in London and New York working for the German bank's global-finance unit successfully bet that borrowing costs in euros, U.S. dollars and British pounds over three- and six-month periods would rise faster than one-month interest rates because of deepening stress throughout the global financial system. 
The interest-rate bets included an estimated potential profit of €24 million for each hundredth of a percentage point that the three-month U.S. dollar Libor increased compared with the one-month U.S. dollar Libor, according to the documents. 
The former employee has told regulators that some employees expressed concerns about the risks of the interest-rate bets, according to documents. 
He also said that Deutsche Bank officials dismissed those concerns because the bank could influence the rates they were betting on.
Given how Libor and other similar interest rates are calculated and the fact that Barclays and UBS have acknowledged manipulating these rates, it is clear that Deutsche Bank could have influenced the rates.

The question is "did Deutsche Bank manipulate the rates to profit on these trades?"

At a minimum, the fact that regulators are searching for the answer to this question highlights the need to base Libor and similar interest rates on actual trades.

Regular readers know that your humble blogger has said that fixing Libor and similar benchmark interest rates does not require complex rules and regulatory oversight.  Rather, it simply requires the banks to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, banks with deposits to lend can assess the solvency of the banks looking to borrow.  This unfreezes and keeps unfrozen the inter-bank lending markets.

With this information and unfrozen inter-bank lending markets, Libor and similar benchmark interest rates can be based off of all or a subset of the actual trades in the inter-bank lending market.

This preserves Libor and similar benchmark interest rates as an index that reflects the cost to banks of borrowing in the unsecured debt markets and eliminates the ability of bankers to manipulate the benchmark rate.

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