The LIBOR is useless

A very good PD (public domain) article in this AM's FT Alphaville. The links are worth a look as well.

http://ftalphaville.ft.com/blog/2009/06/22/58316/libor-is-useless/

lj

 

All I have to say in response to all these people (who do, by the way, have a point) is 'so what?'

Yes, LIBOR has its flaws. However, in the recent episode, the mkt has been spectacularly unable to come up with any meaningful alternative. So, for all its issues, LIBOR is with us to stay...

 

I remember a little while ago (a year or so?) there was a great hue and cry that the LIBOR was being manipulated by its constituent banks by them failing to honestly report their costs of borrowing. What is being reported by the FT here is a variation on a theme of this sort of thing. I would not disagree with you that for lack of something better it continues to be used as a benchmark but it is regrettable that fear (perhaps more so than greed this time around) is being tolerated as an excuse for what appears to be happening, again.

lj

 

Well, to be honest, I actually don't think LIBOR is too inaccurate at the moment.

Reason for that resides with one of the good developments that did come out of the LIBOR debacle last year, namely, NYFR. NYFR is a fixing published by Wrightson ICAP that provides a much better snapshot of the funding situation (the methodology was designed by Lou Crandall, Wrightson's Chief Economist, who knows everything there is to know about the US money mkts). At the moment 3M LIBOR is fixing only a few bps lower than NYFR, which suggests to me that LIBOR's actually not too bad.

 

Let me check out the NYFR and I'll post afterwards.

lj

 

I am not a bondsman so excuse the delay. The questions I would have are as follows:
1. Does the fact that the underlyings are different for the two entities have any consequences? In other words they are not measuring the same phenomenon. From a Reuters article about a year ago:
NYFR will encompass unsecured bank funding sources such as certificates of deposits, money market mutual funds and government-sponsored enterprises. Libor is explicitly defined as an interbank deposit rate.
2. I know there is a quoted spread between the NYFR and the LIBOR which I believe Bloomberg has. I don't have access to these data but would ask has there ever been a time when the two have been 'widely' separated?
3. Does the possibility exist that the NYFR is a SSDD (same ....) entity which can be diddled with like, unfortunately, so many other publically available financial data, from the government or elsewhere?

Thanks for your thoughts. I enjoy the discussion.

lj

 

I don't know exactly what the methodology was for coming up with the NYFR rate, but it stands to reason that, in normal times, it would come close to LIBOR. Banking is about selling money retail and buying it wholesale, no different than your corner grocer, except that the commodity in question is money instead of bread. So if your paying x for a deposit, x + some number of basis points is what you'll sell the money received for, and any old fool, even an economist, can come up with a formula that figures out within what range LIBOR should fall given a certain cost of funds.
The problem is in times of stress, it will be far from LIBOR because in those times banks won't lend to each other at any price. Like most economists, this one figured out a pretty good way of calculating normal, but doesn't really know that the abnormal isn't going to fit any model that is based on the idea that you can extrapolate into abnormal times the same behavior as in normal times.
Real life can be modeled 99% of the time. It's the other 1% that can't be modeled.

 

Yes, it does. That's, in fact, one of the reasons for NYFR in the first place. The theory behind LIBOR is for it to measure a fair funding cost for a median bank. This cost (plus an appropriate spread) is then charged the eventual end-borrower (e.g. a corporate or an individual seeking a mtge). Everyone likes the premise, but the devil's, as usual, in the details. One of the fatal flaws of LIBOR is that the poll asks the panel banks ONLY about their funding in the unsecured interbank mkt. When this system was originally designed nobody could envision a situation where term interbank unsecured mkt would effectively shut down, thus rendering LIBOR completely useless as a measure of the funding situation. NYFR rectifies this by asking banks about their funding costs, regardless of the source.

Yes, there was... During the time last year when LIBOR first attracted scrutiny, shortly after Leh (October 08), 3M NYFR was printing arnd 40 bps higher than 3M LIBOR. After the LIBOR issues were brought into focus, the 3M fixing quickly jumped and has remained more or less in line with NYFR since.

Well, anything is possible. The mkt is not perfect and the rate setting mechanisms certainly can be improved (a lot in some cases). I would argue that, actually, the idea behind LIBOR is fair to the end users of bank credit. The problem is the flawed implementation and the inability/unwillingness of the BBA to change and adapt to the times. There are five specific main flaws of LIBOR implementation:
1) Designed to gauge overall funding costs, it only poses a question about the unsecured interbank mkt (see above).
2) In order to provide transparency by revealing individual panel banks' submissions, it, in fact, creates an incentive to post lower rates.
3) Similar to the previous point, by asking 'too personal' a question about 'your bank's funding costs', it provides an incentive to lie.
4) The design of the question and the tiering of the banks in the LIBOR panel means that fixings can vary wildly, which, obviously, makes the average less useful.
5) The fact that the LIBOR poll is conducted at a time when the NY mkt is not fully functional has proven problematic.
All the issues above are addressed by NYFR, which is why it's a useful measure. So the point of NYFR is to correct the glaring problems with LIBOR, while staying true to its spirit. That's pretty good for me, as I like incremental, rather than revolutionary changes in the world of finance.

 

Yes, but, with all due respect, you're not being very constructive here...

LIBOR (or whatever its counterpart) has to fix every day, regardless of whether the mkt is functioning normally or abnormally. As I mentioned in my other post, certain glaring problems with LIBOR have come to light as a result of the 'abnormal' conditions that existed in the money mkts for a period after the Leh collapse. NYFR was designed specifically to address these problems.

I agree with you that we don't know that it's perfect (most likely, it ain't). That is, it might turn out that NYFR has its own flaws, which may or may not come to light during a different 'abnormal' episode. However, it's definitely the case than NYFR is good enough for the types of 99% normal and 1% abnormal times that we have seen so far. I like that.

 

Thanks martinghoul. That was very illuminating.

As for the 99/1 efficacy of the current modelling of market 'happenings', it sounds suspiciously like a Taleb scenario where the wings start to fail the model-builders. I am not a mathematician but power series would seem to suffer from the same disease as a Fourier transform which is that anything can be modelled if one includes enough terms.

However we must do something, I agree, and perhaps enlightened empiricism is as good as anything else, where the 'enlightened' term refers to the fact that the builders appreciate their construction is not the Rosetta stone for the markets and as such can be adjusted (or dumped) if conditions merit it.

lj