Some time ago I worked as a short term interest rate trader. Essentially I took bets on the movements in interest rates out to 1 year. I did this using a portfolio of bank bills, NCD’s (negotiable certificates of deposits), PN’s (promissory notes), Futures (bets on the level of interest rate at some time in the future) and FRA’s (forward rate agreements). For more information please see this RBA paper.
All of this tied together to make up a portfolio and then the interest rate risk was distilled down to what was known as a 180 day equivalent and I had limits around how much interest rate risk I was allowed to take. It was all a lot of fun for a young fella who was trading merrily while his peers were just finishing university and trying to get a job.
But what was also fun was the games that we used to play with the rate sets each morning at 10am – what are known as BBSW rates (Bank Bill Swap Rate) or Libor in other countries.
Basically if you had a position that needed a bit of enhancement you could try to move the price around in the run up to the rate set. You’d do this by buying or selling bank bills in the market in the run up to 10am to try to move the yield. More often than not you’d end up with one of the other big banks on the opposite side trying to bash you into submission so that they could get the price that suited their book. It was almost impossible for any one player to materially influence the actual rate set more than a few points and only very briefly because we all had our limits. And reversing the position after the rate set would have cost more than it was worth.
So it is against this backdrop that I have been thinking about this Barclays LIBOR fixing news and the fine and scandal it has caused. The question I am asking myself is how did Barclays manage to influence the whole market over an extended period in a manner that was material to their borrowing costs all on their own? It strikes me as almost impossible.
So it is interesting to note that other institutions are being looked at.
Just like we have seen in past periods of market turmoil, they are often associated with behaviour that is either illegal or with the benefit of hindsight deemed immoral. My guess is that there is more to this scandal than meets the eye and that this will not be the only market where manipulation of price for short term interest rates or bonds will be exposed.
Central bankers are doing their best to take back the ascendancy and control for the financial system and we heard last night that the BoE and FSA were involved in Barclay’s CEO Diamond’s demise. Equally in the context of the above the move by the ECB overnight to limit the acceptance of some bonds as collateral for loans looks structurally worrying but could simply be a shot across bank management’s bow not necessarily an anti-bailout move.
Time will tell but as the tide runs out there’ll be a few more naked bankers.
www.twitter.com/gregorymckenna
It’s certainly not Barclays alone, which I think was made clear – Barclays are the first to cooperate openly and admit fault, and their fine had been reduced as a consequence, as I understand it. LIBOR after all takes the middle 8 rates from 16 submissions, so coordination had to be there to influence the rate.
For that matter, I’ve read in some of the links that Barclays manipulated the rate to avoid the appearance of stress – is that something that is a known/commonly used indicator? I guess it makes sense, but it baffles me to think that moving the rate reported by a few pips (or was it significantly more?)
Someone pointed out that given the huge sums of money involved (in the hundreds of trillions) even a few pips gets to the billions very quickly.
I worked for Barclays as a project manager back in the early 2000s. I’ve worked for several other UK banks, but let me tell you how it was then. My project required that the bank generated audit reports as part of banking compliance. My estimation was 6 – 9 months work to do this (ratified by other people independently). The executive concerned just didn’t want to know. None of it got done. As long as the primary objective was achieved, any form of legislation or control was seen as an inconvenience and quietly ignored. Nothing new here.
I don’t want to see banksters naked. I want to see them in prison for the crimes of financial terrorism that they repeatedly commit.
Great post, thanks Greg – I had a mentor when I started out in FP who had a similar position, also unwinding takeover banks interest rates books….
His experiences mirrored yours I must say..
It has been claimed all along that Deutsche, RBS and UBS, among many others, were involved, which is why it was possible for the gang of thieves to succeed.
But the other reason they could manipulate it is because libor is merely a reported rate, there was no actual open market trade which they had to influence, so no costly unwind after the fix as you experienced.
While it was somehwat understanable why they did it in the severe funding stress of 2009, what I initially found quite strange is that bankers would be manipulating an interest rate benchmark down in these times.
Logic would tend to favour a lender wanting to charge clients the spread over a higher libor.
This shows just how much cash is flooding the system and how heavily geared and wrongly positioned they must be in the derivatives markets.
The understanding I’ve gotten out of all the reading material is that reporting a high rate to LIBOR for your borrowing cost would influence the perception of being at-risk and that being the reason for being charged a higher rate. I can’t imagine that would have held up if other banks had raised an eyebrow at the numbers not matching their lending activity, but I guess that’s why it’s a cartel.
I was right to be confused, it made little sense except in 2009 when high libor reporting was a sign of major stress.
This is on Naked Capitalism:
http://www.nakedcapitalism.com/2012/07/links-fourth-of-july-3.html
“It was derivatives traders at Barclays who were manipulating LIBOR, apparently in cahoots with other banks (meaning LIBOR is not being manipulated for funding benefits, but to take advantage of customer positions). The Barclays statement on the earlier rate manipulation (2005-2008) made it clear that Barclays might not have benefitted. That suggests the traders at least some of the time were manipulating LIBOR to raise it.”
A couple of comments and Thoughts.
1) A Manipulator is not doing it based on their whole banks position to BBSW or Libor but rather based on their own warehouse/portfolio/book. It is entirely possible that the bank where they work could lose money in total but their book makes money.
2) In Australia / BBSW there is massive leverage between the cash Bank Accepted Bills (BABs) market and the FRA/Swap Rate set market. A trader may have 10 Billion rate setting on one day in their derives book. But only requires buying (sell) 1 billion of BABs to influence the result. It is true they will probably lose the same number of basis points on the BABs that they make on the derivs but the winner is ten times bigger in volume.
3) Believe it or not BABs are not Financial Products (legally) and therefore are not covered by the Corps Act. So there is no insider trading / Market manipulation etc laws covering them.
4) [KARAN} – There are two Libor Manipulation cases ongoing. A) The one were traders conspired between themselves to nudge it up and down a few ticks for their benefit. This was happening prior to the GFC. and B) Where the whole industry (suffering no doubt from Group Thinking) held them 300 to 400 basis points artificially low during the GFC. A lot of reports merge these two issues. Bob Diamond does his best to merge/confuse these issues as he is trying to blame the BOE for both of these.
Yep, I’ve read about the distinction there, I just hadn’t read anything about the discrepancy being in the order of 3-400bps. Those kinds of numbers sound huge, and I can’t imagine banks would get away with it as easily as they apparently did…
Diamond’s mistake here was admitting fault rather than taking a group bargain. I expect to the other 13 or so banks making a group payout and their CEO’s to breath a sigh of relief.
I suspect there won’t even be the clemency offered to Diamond for the others… his departure was more about the CEO “doing the right thing” than anything to do with personal culpability – the FSA and BoE recognise that is more important than ever right now…
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The MSM are clueless on the LIBOR scandal.
The rigging is a symptom of a completely broken rate fixing system.
The idea that a rate as important as LIBOR or BBSW should be calculated he basis on what the 14 panel bank treasurers think they would theoritically lend unsecured to another bank is laughable.
There is no way to verify if any of the banks are really prepared to lend at that rate they quote. Which is the crux of the whole issue.
LIBOR and BBSW should be calculated based off market observable rates.
At least in Australia there are the bank bills auctions (but suprisingly these aren’t actually used to calculate BBSW) that can be used to highlight any strange divergences.
LIBOR and BBSW should be set from the prices of tradeable bank bills that anyone can observe.
That would ensure any that the system can be rigged only if someone is prepared to move into the market and lend or borrow to move the rate.
Australia could easily move to this model as the bank bills auctions already exist and these could just be used as the BBSW rather than having the 14 panellists entering there own rates.
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