LIBOR is becoming less volatile. Part of that is the fact that the Fed is at ZIRP and all banks are supported, but it is interesting to look at these streaks, which are the number of days in a row that LIBOR changed by less than 1 basis point in either direction. We are currently in a streak that has lasted almost two years! Yes, for two years now, we have not had a daily change in LIBOR of more than one bp.
Basically, since the end of the financial crisis, LIBOR has been very “stable.” Prior to 2009 it was unusual for LIBOR to be so stable. I find the summer of 2008 particularly interesting when it comes to LIBOR rates. I remember issues with the energy markets, concerns over Fannie and Freddie, and the fact that large investment firms had gotten to the point of needing to be bought, yet LIBOR remained very stable that entire summer.
Small Changes Are the “Norm”
Whatever “manipulation” was going on, in most cases LIBOR barely moved. In fact, on more than 82% of the days, LIBOR moved by 1 bp or less and almost 92% of the time, the move was two bps or less. Two bps on three-month LIBOR is 0.005% of notional. On a $1 billion exposure, a change of two bps on the setting would mean the difference of about $50,000. It's not exactly chump change, but definitely worth keeping in mind as far as personal finance goes.
The “Big” Moves in LIBOR Are Concentrated Around the Financial Crisis
The period of 2008 was particularly volatile, but that was also true of all markets. Massive swings in stocks and fixed income were the norm. Policy after policy was put in place to calm credit markets, and possibly to control LIBOR.
The big moves in 2007 started in August when the problems at some banks became apparent, but continued throughout the fall as the Fed aggressively pushed Fed funds down and removed the “taint” from using the discount window. By May of 2009, the crisis had subsided and the big moves in LIBOR were largely reactions to that.
Offhand, I'm not sure what drove the bigger moves in 2003 to 2006, but I suspect that there are reasonable answers to those based on world events and central bank activity.
The next chart looks at when those moves of three bps or greater occurred – 2008 sticks out like a sore thumb.
Two Distinct Periods
I think the problems with LIBOR will break down into two distinct phases.
The “Pre-Financial Crisis” period had consistent, but small, amounts of volatility. I think this period will pose problems for investors trying to get money, but will be easy for legislators to go after the banks. Much of the behind-the-scenes information that has become public seems to focus on the pre-crisis period — dealers (and accounts) trying to push LIBOR either way for a basis point or two.
My guess is we will find that there is no particular pattern, and that some days the attempt was to push it higher and some days it was to go lower, which means there may have even been competing “coalitions” on certain days. It will revolve around the specific roll risk on a particular day for any given institution.
Some banks are far more likely to have big “roll” positions on any given day where moving it up and down a couple bps for those days makes a meaningful difference. It looks bad and is bad. It's possible some people will lose jobs and it will probably change how LIBOR is produced over time.
The “Financial Crisis” period had the most volatility. It started in 2007 and didn't really finish until 2009. That was basically the time frame during which fear of bank credit risk was high. There were times when the only source of short-term money for banks was depositors and the central banks. This period of time may be problematic for everyone even when they are trying to track trends in the best finance software.
In short, it looks as though a big effort was made to make LIBOR appear low, in spite of the fact that banks weren't willing to actually lend money to each other anywhere near those levels.
The entire market was watching LIBOR for signs that a bank was in deep trouble. What is LIBOR going to be next? was the consistent question. “Bear raids” were the norm and, as a bank, there was no better way to attract one than submitting a very high LIBOR rate. The push to get LIBOR down was all about trying to calm markets. Banks themselves may have been losing money because of low settings, but wanted low settings in any case, because the alternative was potential nationalization.
This is what makes 2008 potentially more difficult. Banks may not have profited, there was no real lending, and almost everyone was happy to see LIBOR come down. If the pattern was consistent, it helped all borrowers but it didn't help lenders.
Say you lent $1 billion to various companies, and it turns out that LIBOR was off by 50 bps. Each contributor is only worth a fraction of the total, since it is an average. I'm not sure how the fact that some get kicked out and don't count in the average would play into it. In any case, I think all contributors would have to be pursued as a group, rather than individually, to get an effective result.
But the banks didn't benefit. If LIBOR should have been 2%, but was only 1.5%, it is the company that benefitted. The lender is pursuing the bank for setting the wrong rate, but it is the borrower who benefitted. Can the banks use that as a defense? The argument would be that the banks that set the rate low so are responsible. The borrowers would claim innocence.
Can LIBOR Be Systematically Restated? If LIBOR Was Restated, Would Lenders Have to Pursue the Borrowers Individually?
I think the pre-crisis period is relatively tame. Small moves in both directions means it will likely be hard to find anyone who was consistently harmed, or harmed enough to justify the legal costs, especially since you cannot really pursue just one bank and the size of any potential manipulation appears to have happened in the pre-crisis era.
In the post-crisis era, finance software often makes it seem as if it was more likely that a consistent pattern was in existence, though it is unclear whether the definition of LIBOR is weak enough that a bank could defend its actions by showing an absence of trading and its own rationale for why its LIBOR met the definition.
Again, I haven't looked closely at bank-by-bank submissions, but it looks like in the pre-crisis era, banks attempted to get small moves in their favor in either direction as they needed. Here is why even finding one bank isn't enough.
Currently US LIBOR is set by 18 banks. Each bank provides a “submission.” The four lowest and the four highest are thrown out and LIBOR is the average of the other 10 (the number of contributors and who contributed has changed over time).
For now, let's assume that there is a way to verify what the “real” rate for any bank is. Remember, the question is where they “think” someone would lend to them. If they are busy borrowing money from their central bank and don't ask another bank, it is possible that it will be very hard to prove they misstated the rate – or by how much. That is another separate question entirely.
The complexity of what LIBOR is and how to prove loss is enormous. I think derivative cases and pre-crisis cases will have a tougher time finding damages that are easily attributable.
“Facts About LIBOR and the Potential Implications” was provided by Minyanville.com.
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