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.