What would have happened had banks not estimated LIBOR?
Discussion
The mechanics of LIBOR data collection is such that banks would be asked at what rate could they borrow money in the interbank market (in a variety of terms and currencies).
When the financial crisis was in full swing, Lehmans collapsed and liquidity was nil, the answer would have been either:
1. We can't; or
2. 100% ( or some other similar HUGE number to reflect the fact that banks weren't lending to eachother.
So, LIBOR would have catastrophically risen to unheard of levels. Mortgage rates pegged to LIBOR would have shot up to unpayable rates.
Maybe the banks should have just done that so the true catastrophe could have been unleashed once and for all.
Would that have been a better result for the economy.
When the financial crisis was in full swing, Lehmans collapsed and liquidity was nil, the answer would have been either:
1. We can't; or
2. 100% ( or some other similar HUGE number to reflect the fact that banks weren't lending to eachother.
So, LIBOR would have catastrophically risen to unheard of levels. Mortgage rates pegged to LIBOR would have shot up to unpayable rates.
Maybe the banks should have just done that so the true catastrophe could have been unleashed once and for all.
Would that have been a better result for the economy.
johnfm said:
The mechanics of LIBOR data collection is such that banks would be asked at what rate could they borrow money in the interbank market (in a variety of terms and currencies).
When the financial crisis was in full swing, Lehmans collapsed and liquidity was nil, the answer would have been either:
1. We can't; or
2. 100% ( or some other similar HUGE number to reflect the fact that banks weren't lending to eachother.
So, LIBOR would have catastrophically risen to unheard of levels. Mortgage rates pegged to LIBOR would have shot up to unpayable rates.
Maybe the banks should have just done that so the true catastrophe could have been unleashed once and for all.
Would that have been a better result for the economy.
I don't disagree too much with apocalypse scenario, it certainly could have happened. My problem is that they were doing this 2-3 years before the credit crunch and on short term rates. That was simply to manipulate the rate in their favour or posting a rate at the request of other banks, to help those banks out.When the financial crisis was in full swing, Lehmans collapsed and liquidity was nil, the answer would have been either:
1. We can't; or
2. 100% ( or some other similar HUGE number to reflect the fact that banks weren't lending to eachother.
So, LIBOR would have catastrophically risen to unheard of levels. Mortgage rates pegged to LIBOR would have shot up to unpayable rates.
Maybe the banks should have just done that so the true catastrophe could have been unleashed once and for all.
Would that have been a better result for the economy.
The nature of setting of LIBOR seems to be
Dear Banks
Gives us an estimate please so we can make up a number that you all must use in any LIBOR related trades.
I expect the nature of bank trading is such that some deals will be in the money if LIBOR is low and others in LIBOR is higher. Overall, you would expect it to be zero sum - ie, the banks overall make or lose nothing irrespective of the rate being 3.145 or 3.150 or whatever.
If the FSA really knew what they were doing, surely they would have by now created a more robust method of calculating LIBOR.
Dear Banks
Gives us an estimate please so we can make up a number that you all must use in any LIBOR related trades.
I expect the nature of bank trading is such that some deals will be in the money if LIBOR is low and others in LIBOR is higher. Overall, you would expect it to be zero sum - ie, the banks overall make or lose nothing irrespective of the rate being 3.145 or 3.150 or whatever.
If the FSA really knew what they were doing, surely they would have by now created a more robust method of calculating LIBOR.
johnfm said:
If the FSA really knew what they were doing, surely they would have by now created a more robust method of calculating LIBOR.
It wouldn't be the FSA's role to prescribe the calculation, in the same way they wouldn't say whether a stock is priced correctly. Their remit is to monitor market conduct, identify abuse and/or manipulation, as they have done. 
ts nowadays. as found in exchange squarejohnfm said:
I expect the nature of bank trading is such that some deals will be in the money if LIBOR is low and others in LIBOR is higher. Overall, you would expect it to be zero sum - ie, the banks overall make or lose nothing irrespective of the rate being 3.145 or 3.150 or whatever.
Correct. All major banks will have LIBOR exposure, mainly from interest rate derivatives. They may be long or short LIBOR depending on their position.For example, suppose I am a bank. Here is a simple interest rate derivative (a swap) that we do with each other
- Every 3 months, you pay me 2% interest on 100000 GBP
- At the same time, I pay you LIBOR on 100000 GBP
If banks are trading with each other, the exposure nets out to some extent since one bank's loss is another's gain, so it isn't in their interest to collaborate in setting the rate. But imagine a scenario where many banks are selling these swaps to non-bank entities, such as small businesses or pension funds, and they all know this. You now have a situation where the banks, collectively, may wish LIBOR to take a certain direction in order to maximise revenues. And the problem starts.
You could wonder why banks would be dishonest over LIBOR. LIBOR is the rate at which they will agree to lend to each other, so if they get it too low, surely they lose out on interest payments? And if they set it too high, surely they lose out on business? The answer is that the profits to be had from interbank lending are dwarfed by the profits to be had on derivative contracts, which can be vast.
johnfm said:
If the FSA really knew what they were doing, surely they would have by now created a more robust method of calculating LIBOR.
It's difficult to know what form that could take. Right now, the only concession to robustness is that (from memory) the top and bottom entries in the LIBOR submissions are discarded, to avoid banks trying to blatently skew the rate.LIBOR is the rate at which banks will lend to each other, so you can't really set it without asking the banks.
You could create another benchmark, but in the interests of market transparency you have to disclose the calculation, and as soon as you do that you are opening the system to abuse.
The only thing I can think of is to open the pool of banks to a much wider range of financial institutions, to reduce the likelihood of collaboration having an effect on the final result. And hang anyone found guilty of market abuse.
12gauge said:
Yup. All the interventions have done is postpone a financial crisis by creating a sovereign crisis. Well done Brown.
Im sure all the hooray henry city boys on here will be along to set me straight shortly...
thats right, the national debt, infunded public sector pensions, pfi and deficit were tip fvcking top in 2007 wern't they? hooray henry? haha. you've never been near a trading floor in your life have you?Im sure all the hooray henry city boys on here will be along to set me straight shortly...
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