Anonymous Libor Expert Explains on How the Fed has Destroyed LIBOR

As explained by an anonymous Libor ‘trader’ expert, courtesy of the Business Insider, (bold emphasis added)

LIBOR isn't really based on a tangible number; it's based on a compilation of bank responses to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"

Banks need to find money to settle transactions denominated in other currencies or involving transactions abroad. Therefore they use instruments like Eurodollar futures, which allows them to borrow or lend dollars at banks outside the United States for a certain period of time.

The effects of any central bank action are felt directly in these markets. When the Federal Reserve wants to lower the federal funds rate, it uses open market operations—this means it states its intention of depositing more money in banks' accounts at the Fed, making it cheaper for other financial firms to get dollars.

In the years leading up to the financial crisis, the relative stability in rates allowed algorithmic traders to take advantage of very minute changes in LIBOR at various maturities, like those mentioned by Barclays traders in documents released by European regulators. The Fed and other central banks could control that rate by adjusting interest rates, but LIBOR moved pretty much in tandem with the federal funds rate.

"My colleagues and I, we say that [LIBOR] is 14 bps over the federal funds rate...as a joke," the trader told Business Insider, pointing to the uncanny correlation between the two rates up until 2007 and since 2009. When the rate at which banks lent to each other began to jump in late 2007, however, "the system couldn't take it at all," he added.

In the lead-up to and during the financial crisis, real interbank lending for any length of time beyond overnight practically stopped. Thus, saying that banks were pushing down their reports of the prices at which they could borrow is at best misleading, because the demand for lending long-term was nonexistent.

"We submitted a hallucination," said the source.

Central banks responded to the credit stress by offering massive lending facilities, which allowed banks to to access money—in particular, dollars—through a vehicle outside the traditional private money markets. That has changed the way the markets work.

The trader explained, "Since the crisis, banks don't fund themselves [through the traditional money markets] because they don't want to. It's really now about old contracts," that were purchased ahead of the crisis.

But while markets may have exited the crisis credit crunch, markets for securities determined by LIBOR have not, the trader told us. Instead, he says there's an implicit push by the Fed to keep the lending rate low, even though it should be much higher now.

By releasing interest rate projections and jumping to non-standard measures like quantitative easing and dollar facilities, the Fed destroys the incentive to actually exchange money via Eurodollar contracts. This means the Fed is refusing to let LIBOR function as a true, independent indicator.

"If you're long the TED [you believe there will be more financial stress] in a time of trouble, you buy T-bills and take the money offered to you, so you sell a Eurodollar." Essentially, you believe you'll be profiting off of higher lending costs for banks in the future. But if the LIBOR is kept artificially low, then you lose money on a Eurodollar futures contract.

But now, the Fed has become so committed to keeping interest rates down indefinitely—and has jumped so quickly to measures that distort the market—that it has completely destroyed any faith or interest in new contracts.

The trader believed that central banks have recognized that disaster happens when the LIBOR begins to deviate from its general relationship to the federal funds rate, and therefore the Fed (and perhaps other central banks) have suppressed it to make sure rising rates don't generate fear while it develops another money market system.

"I think what they want to do is make sure the system doesn't go crazy." Otherwise, he argues, "You're not just embracing a fantasy. You're embracing a fantasy that created the great credit bubble."

The above observation has basically been congruent with my earlier thesis

Barclay’s LIBOR Scandal: Self Fulfilling Turmoil

The Barclay’s LIBOR scandal seems to be rippling across the world.

From the Bloomberg,

Regulators from Stockholm to Seoul are re-examining how benchmark borrowing costs are set amid concern they are just as vulnerable to manipulation as the London interbank offered rate.

Stibor, Sweden’s main interbank rate, and Tibor in Japan are among rates facing fresh scrutiny because, like Libor, they are based on banks’ estimated borrowing costs rather than real trades. In some cases they may be easier to rig than Libor as fewer banks contribute to their calculation, according to academics and analysts.

“Many of the ingredients which made it pretty easy to manipulate Libor and collude are common in other benchmarks,” said Rosa Abrantes-Metz, an economist with consulting firm Global Economics Group and an associate professor at New York University’s Stern School of Business. “Regulatory agencies are starting to take a look at those and there is a growing sense they need to change.”

Barclays Plc (BARC), the U.K.’s second-largest bank, was fined a record 290 million pounds ($450 million) last month for attempting to rig Libor and Euribor, its equivalent in euros, to appear more healthy during the financial crisis and boost earnings before it. At least 12 banks including Royal Bank of Scotland Group Plc (RBS) and Deutsche Bank AG are being investigated for manipulating Libor.

Regulators and industry groups are now turning their attention to whether other benchmark rates were manipulated in the same way. Sweden’s central bank, the Japanese Bankers Association, the Monetary Authority of Singapore and South Korea’s Fair Trade Commission have all announced probes into how their domestic rates are set.

Derivatives Traders

Libor is determined by a daily poll carried out on behalf of the British Bankers’ Association that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies.

The issue is here is that interest rates have been manipulated thereby prompting speculations that there might have been large discrepancies in the pricing of interest rates that affects much of the world financial markets.

The so-called manipulations occurred at the peak of the crisis in 2008 and has reportedly even been warned by NY Fed’s then President Timothy Geithner and so as with the BIS.

Apparently NO one took LEGAL action or that authorities simply looked the other way.

Now this has become a big issue.

But the much of the agog (impact of price manipulations) out of the LIBOR scandal has barely been a fact.

In spite of the alleged Libor shenanigans, Professor Gary North shows here in numerous charts that interest rates had been determined by the markets.

Writes Professor North, (bold original)

There is no sign that these two gigantic and interlinked credit markets were different in any significant sense over the entire decade. In other words, Barclays bank had no influence over rates. The banks that were involved rigged the system from 2005 to 2009.

Then what is the scandal all about? Ignorance of basic economics. What about the banks that manipulated the LIBOR rate? They made money on the margin, but they did not have any significant effect on these rates. You can see this in the LIBOR charts.

The scandal is a tempest in a teapot. No one lost much money. The banks did not keep rates lower than the market for more than a few hours -- maybe days, but I want to see proof.

The rates were governed by market forces.

The idea that Barclays kept rates down for years is ludicrous. No commercial bank can keep rates down if investors are willing to pay for a different allocation of capital than what the banks want. The bankers can make money at the margin, paying a little less for loans. But after 2008, none of this mattered. Bankers did not want to borrow from each other.

The appalling ignorance of basic economic theory is why we see the headlines about Barclays and the manipulation of rates. Bankers probably made many millions of pounds extra, but this had no measurable effect on the direction of interest rates. We are not talking about hundreds of billions. We are not talking about the Bank of England.

Columnists like to get attention. There is nothing like a scandal to get attention. But to say that the commercial banks manipulated inter-bank rates is saying that (1) central banks and reserve requirements don't count for much; (2) market rates can be held down by a few commercial banks, thereby overcoming the market for capital: lenders and borrowers.

The people who cry "scandal" do not think through the implications of what they are saying. Making a lot of money is one thing. It is possible. Re-structuring the derivatives market totaling about a quadrillion dollars in assets/promises is something else.

The problem has little to do with rate-tinkering by Barclays and the others. The problem, then as now, is the misguided Keynesianism that undergirds the policy decisions of the West's central bankers.

In reality, the major manipulators of the markets has been the central bankers led by the US Federal Reserve, who seem to be looking to divert the public’s attention from the real causes of the present imbalances: central banking inflationism.

With allegations that banks has been culpable for the manipulations of the interest rates the reactions will likely be a tsunami of lawsuits, of course calls for tighter regulations (which may be the real intent of the scandal-mongerers)

From another Bloomberg article,

Wall Street, grappling with mounting regulatory probes and investor claims over alleged interest-rate manipulation, may face yet another formidable foe: Itself.

Goldman Sachs Group Inc. (GS) and Morgan Stanley are among financial firms that may bring lawsuits against their biggest rivals as regulators on three continents examine whether other banks manipulated the London interbank offered rate, known as Libor, said Bradley Hintz, an analyst with Sanford C. Bernstein & Co. Even if Goldman Sachs and Morgan Stanley forgo claims on their own behalf, they oversee money-market funds that may be required to pursue restitution for injured clients, he said.

Because Libor is based on submissions from only some of the world’s largest banks, the probes threaten to pit firms uninvolved in setting the rate against any implicated in its manipulation, Hintz said. Libor serves as a benchmark for at least $360 trillion in securities.

“This will be a feeding frenzy of sharks,” said Hintz, who has served as treasurer of Morgan Stanley (MS) and chief financial officer of Lehman Brothers Holdings Inc. “We’re going to have Wall Street suing Wall Street.”

It’s definitely going to be a feeding frenzy especially for politicians whom are likely to use the current sentiment against Wall Street (Occupy Wall Street) and the global financial industry as fodder for electoral mudslinging or as an opportunity to acquire votes with the US national elections fast approaching.

Wall Street rending each other apart will likely exacerbate the prevailing uncertainty.

Barclay’s Libor Scandal: The US Federal Reserve as the Biggest Manipulator

Since 2008 it has been obvious that the US Federal Reserve through its manifold tools has been engaged in the manipulation of interest rates. Here is the alphabet soup of the Fed’s tools

I pointed this out earlier here

Nevertheless the Zero Hedge shows partly how the manipulation process has been done (hat tip Bob Wenzel) [bold original]

Via Peter Tchir of TF Market Advisors,

The Fed does everything it can to keep LIBOR low.

This chart says it all.

The Fed cannot affect LIBOR directly, but in general LIBOR trades in line with Fed Funds. You can see that historically as Fed Funds was changed, LIBOR responded appropriately. There was typically some small premium to reflect the "credit risk" of banks versus the Fed, but it was relatively small, and fairly stable. 3 Month LIBOR would deviate a bit as rate cuts and hikes were anticipated in the market, but in general, it was a fairly stable game.

That all started to break down in 2007. We saw the first real signs of LIBOR deviating from its normal spread to Fed Funds in the summer of 2007. The Fed responded by cutting the "penalty" rate for using the discount window, and in fact encouraged banks to use the discount window (I still can't shake the mental image of someone sitting in a dark basement with a green eye-shade doling out money to banks that request it). Then the crisis got worse. Bear needed to be rescued. Facilities such as the Term Auction Facility that had been put in earlier were increased in size. The Fed backstopped some portfolios that JPM acquired as part of the Bear Stearns deal.

As the crisis re-ignited in the late summer of 2008 and peaked after Lehman and AIG, the Fed took step after step to reduce borrowing costs. The Fed was blatantly clear that it wanted borrowing costs to go down. They had the obvious tool of reducing Fed Funds to virtually zero, but when LIBOR didn't follow, the Fed took further action. The Fed did not want bank borrowing costs to be high.

They increased dollar swap lines so foreign banks could borrow. The Fed stepped into the commercial paper market so banks wouldn't have to use money to meet drawdowns on revolvers. TALF was another creation to take pressure of bank lending.

The FDIC allowed banks to issue bonds with FDIC backing (so not quite Fed program, but who is going to quibble).

Fears that MS and GS and GE would topple the banks were alleviated by making them banks.

The list goes on. The Fed has done a lot and trying to control LIBOR as a key borrowing rate is one of the things they have worked on, both directly and indirectly.

In reality, central banks worldwide have been working round the clock to rein interest rates almost at every channel.

Bailouts are part of the umbrella mechanism of interest rate controls, as they prevent markets from revealing the real conditions of people’s time preferences over money and from the clearing of the loan markets—suppliers and demanders of loan.

And the biggest evidence is the scale of balance sheet expansions of the G-4 central banks since 2008 with the US Federal Reserve as the leader. (cumber.com)

Barclay’s LIBOR Scandal: Is the Bank of England the Culprit?

Barclays chief executive Bob Diamond recently resigned over allegations of the manipulation of the LIBOR (London Interbank Offered Rate) or the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks (Wikipedia.org)

From Reuters (bold highlights mine)

Barclays chief executive Bob Diamond suddenly quit on Tuesday over an interest rate-rigging scandal that threatens to drag in a dozen more major lenders but suggested the Bank of England had encouraged his bank to manipulate the figures.

"The external pressure placed on Barclays has reached a level that risks damaging the franchise - I cannot let that happen," said Diamond, 60. The terms of his severance were not announced, though Sky News said the bank would ask Diamond to forfeit almost 20 million pounds ($30 million) in bonuses.

Politicians and newspapers have zeroed in on the scandal - which revealed macho e-mails of bankers congratulating each other with offers of champagne for helping to fiddle figures - as an example of a rampant culture of wrongdoing in an industry that stayed afloat with huge taxpayer bailouts.

Barclays released an internal 2008 memo from Diamond, then head of its investment bank, suggesting that the deputy governor of the Bank of England, Paul Tucker, had given Barclays implicit encouragement to massage the interest figures lower during the peak of the financial crisis in order to present a better picture of the bank's financial position.

Here is the principle, central banks are the only entities permitted to manipulate interest rates…

…but they need accomplices.

More from Zero Hedge

Wonder who was pushing Barclays to manipulate its rate? Why none other than the English Fed. From BBG:

• BARCLAYS SAYS BANK OF ENGLAND CALLED ON OCT. 29, 2008 ON LIBOR
• BARCLAYS SAYS DIAMOND MADE NOTE OF CALL
• BARCLAYS SAYS DIAMOND RECEIVED CALL FROM PAUL TUCKER
• BARCLAYS SAYS TUCKER SAID `CERTAIN' BARCLAYS DIDN'T NEED ADVICE
• BARCLAYS SAYS TUCKER SAID DIDN'T ALWAYS NEED TO BE SO HIGH (Supposedly LIBOR)
• BARCLAYS PROVIDES COPY OF DIAMOND'S CALL NOTE
• BARCLAYS SAYS DIAMOND DIDN'T BELIEVE HE HAD GOT INSTRUCTION
• BARCLAYS SAYS DEL MISSIER CONCLUDED INSTRUCTION HAD BEEN GIVEN
• BARCLAYS SAYS DEL MISSIER TOLD RATE SETTERS TO LOWER RATES

In other words, a central banks was directly and indirectly involved in manipulating interest rates. Say it isn't so. Fast forward two months when the BOE's Tucker testifies that the Chairsatan made him do it.

Hoping to take the political heat off what seems obvious, Barclay’s and Bob Diamond has served as BoE’s fall guy.