1 00:00:11,080 --> 00:00:14,600 Speaker 1: Hello, and welcome to another episode of the Odd Thoughts podcast. 2 00:00:14,720 --> 00:00:19,639 Speaker 1: I'm Tracy Allaway and I'm Joe. Wisn't all so, Joe. 3 00:00:19,760 --> 00:00:23,560 Speaker 1: We're finally doing it. We're finally doing our live ard series. 4 00:00:24,920 --> 00:00:28,000 Speaker 1: Uh yeah, we've been talking about this for a while, 5 00:00:28,320 --> 00:00:33,600 Speaker 1: the idea of doing a big series on librar, what 6 00:00:33,760 --> 00:00:36,960 Speaker 1: happened to it, what it was, what his state is now, 7 00:00:37,159 --> 00:00:41,239 Speaker 1: where it's going, and uh, we're going to kick it off. Yep. 8 00:00:41,440 --> 00:00:43,960 Speaker 1: This is the first of those episodes. So just as 9 00:00:44,000 --> 00:00:47,760 Speaker 1: an introduction, let's talk about what libor is. Librar is 10 00:00:47,800 --> 00:00:52,240 Speaker 1: the London Interbank Offered rate, and it is, as you mentioned, Joe, 11 00:00:52,320 --> 00:00:56,400 Speaker 1: in a state of transition. Just for background, this is 12 00:00:56,560 --> 00:01:00,600 Speaker 1: basically the reference rate that governs trillions of dollars worth 13 00:01:00,600 --> 00:01:03,040 Speaker 1: of asset prices. So, for instance, if you sell a 14 00:01:03,040 --> 00:01:05,640 Speaker 1: bond in the market, it will be priced off lib 15 00:01:05,800 --> 00:01:08,840 Speaker 1: or um, so whatever the inter bank offered rate is 16 00:01:08,959 --> 00:01:12,000 Speaker 1: plus an additional yield. Same thing if you sell alone 17 00:01:12,640 --> 00:01:16,679 Speaker 1: home mortgages priced off lib or. Basically, the financial system 18 00:01:16,800 --> 00:01:20,479 Speaker 1: has for many many years run on library and that 19 00:01:20,600 --> 00:01:22,800 Speaker 1: is a big deal because we are supposed to be 20 00:01:22,840 --> 00:01:27,800 Speaker 1: moving away from that particular reference rate, right, So this 21 00:01:27,880 --> 00:01:30,680 Speaker 1: is not a topic that I know particularly well. I 22 00:01:30,760 --> 00:01:34,600 Speaker 1: know about the centrality of the rate. I know that 23 00:01:34,640 --> 00:01:38,480 Speaker 1: there is an effort afoot to move all of these 24 00:01:38,600 --> 00:01:42,919 Speaker 1: various offerings that currently index in some way to libel 25 00:01:43,120 --> 00:01:45,880 Speaker 1: onto something new, which will get to in this series. 26 00:01:46,520 --> 00:01:49,640 Speaker 1: And I know that around the time of the crisis 27 00:01:50,000 --> 00:01:52,080 Speaker 1: there was a manipulation of this price and that that 28 00:01:52,160 --> 00:01:54,720 Speaker 1: was a major scandal, and that the way the price 29 00:01:54,800 --> 00:01:59,240 Speaker 1: is set and measured opened itself to all kinds of shenanigans. 30 00:01:59,280 --> 00:02:02,320 Speaker 1: But honestly, I don't know much more about it than that. 31 00:02:02,400 --> 00:02:04,280 Speaker 1: I don't know much about its history. I don't know 32 00:02:04,320 --> 00:02:09,680 Speaker 1: the degree to which the manipulation really affected things. I 33 00:02:09,720 --> 00:02:12,600 Speaker 1: don't know why it's so difficult to change, and I'm 34 00:02:12,720 --> 00:02:16,160 Speaker 1: very much looking forward to learning more as we embark 35 00:02:16,240 --> 00:02:18,720 Speaker 1: on this series, because although I don't know very much 36 00:02:18,760 --> 00:02:21,080 Speaker 1: about it, I get the sense that this is extremely 37 00:02:21,080 --> 00:02:24,480 Speaker 1: important and that people in credit market it's one of 38 00:02:24,560 --> 00:02:27,360 Speaker 1: the big things that is going to affect their industry, 39 00:02:27,360 --> 00:02:30,960 Speaker 1: and that they're all watching absolutely And you've set the 40 00:02:30,960 --> 00:02:35,200 Speaker 1: scene perfectly, and we are actually going to start with 41 00:02:35,240 --> 00:02:37,840 Speaker 1: a discussion about what lib or is, how it came 42 00:02:37,840 --> 00:02:41,880 Speaker 1: into being and of course the manipulation scandal that happened 43 00:02:41,960 --> 00:02:45,600 Speaker 1: after the financial crisis. So it's a good place to start. 44 00:02:46,040 --> 00:02:49,320 Speaker 1: And our guest is actually the perfect guests to talk 45 00:02:49,360 --> 00:02:52,760 Speaker 1: about this. Uh. He's basically been a Cassandra when it 46 00:02:52,800 --> 00:02:56,560 Speaker 1: comes to warning about the potential for banks to do 47 00:02:56,800 --> 00:03:00,960 Speaker 1: sketchy stuff with lib or. His name is Richard Rob. 48 00:03:01,120 --> 00:03:04,320 Speaker 1: He's currently the CEO of the hedge fund Christoffers and 49 00:03:04,400 --> 00:03:08,680 Speaker 1: Rob also a professor at Columbia and many many years ago, 50 00:03:09,000 --> 00:03:12,720 Speaker 1: he was actually a rates trader at d KB Financial 51 00:03:12,800 --> 00:03:16,000 Speaker 1: in New York, and he famously wrote a letter to 52 00:03:16,080 --> 00:03:19,760 Speaker 1: one of the regulators, the CFDC, warning of the potential 53 00:03:19,880 --> 00:03:23,640 Speaker 1: for library manipulation. And this was way back in I 54 00:03:23,680 --> 00:03:28,320 Speaker 1: think the late So really the perfect person to discuss this. 55 00:03:29,560 --> 00:03:33,960 Speaker 1: I can't wait. I can't wait to learn all about it. Excellent, Richard, 56 00:03:34,320 --> 00:03:36,840 Speaker 1: thank you so much for coming on. Great to be here, 57 00:03:37,480 --> 00:03:41,040 Speaker 1: so I guess too. Just to begin with, I'm curious, 58 00:03:41,080 --> 00:03:43,600 Speaker 1: what was it like being a rates trader in the nineties. 59 00:03:43,720 --> 00:03:45,640 Speaker 1: Quite a lot happening back then when it comes to 60 00:03:45,680 --> 00:03:51,160 Speaker 1: interest rates. Oh, it was so much fun. Um the 61 00:03:51,200 --> 00:03:54,200 Speaker 1: interest rates would move ten fifteen bases points. Today the 62 00:03:54,200 --> 00:03:56,960 Speaker 1: interbank market was very active. You know, the ib and 63 00:03:57,080 --> 00:04:00,560 Speaker 1: lib or stands for interbank. So banks would and borrow 64 00:04:00,560 --> 00:04:02,840 Speaker 1: and lend to each other, and the rates that they 65 00:04:02,880 --> 00:04:06,840 Speaker 1: would lend were important to the banks. They're important to 66 00:04:06,880 --> 00:04:10,640 Speaker 1: financial markets at the time. So d k B was 67 00:04:12,040 --> 00:04:14,680 Speaker 1: stands for Dai Chi Kangyo Bank and we're actually the 68 00:04:14,800 --> 00:04:17,560 Speaker 1: largest bank in the world at the time. And you know, 69 00:04:18,000 --> 00:04:22,240 Speaker 1: I know it's my students Columbia, Japanese students and some 70 00:04:22,320 --> 00:04:24,120 Speaker 1: of them, you know, have never heard of d k B. 71 00:04:24,240 --> 00:04:26,800 Speaker 1: It kind of breaks my heart, you know. But then 72 00:04:27,480 --> 00:04:31,600 Speaker 1: my my students at Columbia, Uh, it breaks my heart 73 00:04:31,640 --> 00:04:34,480 Speaker 1: that they haven't heard of d k B because a 74 00:04:35,120 --> 00:04:37,479 Speaker 1: great bank. It was a fun place to work. It's 75 00:04:37,560 --> 00:04:41,919 Speaker 1: merged and formed Mizuho now, which readers will know, listeners 76 00:04:41,920 --> 00:04:46,039 Speaker 1: will know. The capital markets were developing. They're developing in Japan, 77 00:04:47,680 --> 00:04:51,120 Speaker 1: and it was kind of the heyday of financial engineering 78 00:04:51,160 --> 00:04:55,000 Speaker 1: before the word term financial engineering became, um, you know, 79 00:04:55,800 --> 00:04:58,320 Speaker 1: a way to disparage. You know, it's an exercise, and 80 00:04:58,320 --> 00:05:00,919 Speaker 1: financial engineering and those as it was something to be 81 00:05:00,960 --> 00:05:05,159 Speaker 1: proud of. So let's you know, let's really break this 82 00:05:05,240 --> 00:05:08,800 Speaker 1: down into simple basic ideas for people like me and 83 00:05:08,839 --> 00:05:11,640 Speaker 1: maybe a few of our listeners who don't know as much. 84 00:05:11,880 --> 00:05:16,080 Speaker 1: You mentioned, uh, you know, the ib and library inter bank. 85 00:05:16,800 --> 00:05:21,719 Speaker 1: What was it attempting to measure specifically and why did 86 00:05:21,960 --> 00:05:24,960 Speaker 1: did this need there to be an index at all? Yeah, well, 87 00:05:24,960 --> 00:05:30,000 Speaker 1: this was created by the British Bankers Association. It was 88 00:05:30,200 --> 00:05:34,760 Speaker 1: meant to provide a benchmark index for short term borrowing costs, 89 00:05:34,760 --> 00:05:38,080 Speaker 1: originally for banks, and then over time that was extended 90 00:05:38,120 --> 00:05:43,160 Speaker 1: to companies, to loans, to home mortgages, and then into 91 00:05:43,279 --> 00:05:46,279 Speaker 1: many different currencies as well as U S dollars. The 92 00:05:46,320 --> 00:05:49,560 Speaker 1: index was created for not just three months live or 93 00:05:49,640 --> 00:05:53,919 Speaker 1: but six months, one year and various other terms of 94 00:05:54,040 --> 00:05:56,760 Speaker 1: one year and less. So it's set once a day 95 00:05:56,800 --> 00:06:01,560 Speaker 1: in London. It's meant to reflect the term the L 96 00:06:01,760 --> 00:06:05,800 Speaker 1: in Library can be confusing. It it really stands for 97 00:06:05,880 --> 00:06:10,240 Speaker 1: offshore when offshore activity was headquartered in London, but it 98 00:06:10,279 --> 00:06:14,240 Speaker 1: can be a deposit booked in Cayman or Nassau or 99 00:06:14,360 --> 00:06:18,720 Speaker 1: London or any place that's outside of the scope of 100 00:06:18,720 --> 00:06:24,040 Speaker 1: of taxation or deposit insurance to reflect the truest cost 101 00:06:24,120 --> 00:06:27,040 Speaker 1: of funds that a bank would encounter without any of 102 00:06:27,080 --> 00:06:33,000 Speaker 1: these special institutional details that might be UH, come with 103 00:06:33,040 --> 00:06:36,640 Speaker 1: an onshore deposit. It's been a survey. It's always been 104 00:06:36,680 --> 00:06:38,880 Speaker 1: a survey. And at the time the question that was 105 00:06:38,920 --> 00:06:42,040 Speaker 1: created by the British Bankers Association was to pull banks 106 00:06:42,520 --> 00:06:44,279 Speaker 1: and they would ask them, if you were to go 107 00:06:44,320 --> 00:06:50,040 Speaker 1: out and borrow US dollars at to call another bank 108 00:06:50,560 --> 00:06:54,640 Speaker 1: and in UH in normal size, what rate did you 109 00:06:54,760 --> 00:06:57,000 Speaker 1: perceive you would be able to borrow if you didn't 110 00:06:57,040 --> 00:06:59,960 Speaker 1: negotiate the price. So that's what makes it the off 111 00:07:00,000 --> 00:07:02,640 Speaker 1: heard side. You call, you don't negotiate, and you say 112 00:07:02,640 --> 00:07:07,640 Speaker 1: where where could I borrow money? M What made libror 113 00:07:07,839 --> 00:07:11,440 Speaker 1: special compared to other interest rates that were in use 114 00:07:11,760 --> 00:07:14,280 Speaker 1: in the eighties or the nineties. Why did the market 115 00:07:14,360 --> 00:07:20,000 Speaker 1: need an expected rate versus an actual rate? You know, 116 00:07:20,600 --> 00:07:27,400 Speaker 1: we had the prime rate, which was UH. Some some 117 00:07:27,680 --> 00:07:31,280 Speaker 1: loans and derivatives were based off the US prime rate, 118 00:07:31,760 --> 00:07:35,760 Speaker 1: which was a hard thing to understand. It was set 119 00:07:35,800 --> 00:07:38,920 Speaker 1: by banks. Different banks would have different prime rates, and 120 00:07:39,000 --> 00:07:43,520 Speaker 1: there wasn't much theory. There wasn't sometimes it wouldn't respond 121 00:07:43,600 --> 00:07:48,400 Speaker 1: to market developments. It was and in each bank, which 122 00:07:48,440 --> 00:07:52,960 Speaker 1: set it at its own discretion um there was so 123 00:07:53,520 --> 00:07:56,560 Speaker 1: the market needed an index. If you wanted to borrow 124 00:07:56,600 --> 00:07:59,600 Speaker 1: money and you wanted the rate to go up. You 125 00:07:59,680 --> 00:08:02,240 Speaker 1: could except the rate going up if inflation went up 126 00:08:02,720 --> 00:08:05,440 Speaker 1: or short term rates go up according to the business cycle. 127 00:08:05,840 --> 00:08:08,720 Speaker 1: This was the index. Another know, another possibility would be 128 00:08:08,760 --> 00:08:12,520 Speaker 1: to use US Treasury bills, but those have their own 129 00:08:12,520 --> 00:08:15,800 Speaker 1: special features that might not be relevant to a company 130 00:08:15,840 --> 00:08:18,720 Speaker 1: that was borrowing or a bank that was borrowing. The 131 00:08:18,800 --> 00:08:21,240 Speaker 1: rate on US Treasury bills could depend on the supply 132 00:08:21,280 --> 00:08:26,120 Speaker 1: and demand of T bills. It could depend on yeah 133 00:08:26,960 --> 00:08:29,520 Speaker 1: costs of borrowing in the private credit markets could go 134 00:08:29,600 --> 00:08:33,600 Speaker 1: up without a corresponding change in Treasury bills, and banks 135 00:08:33,600 --> 00:08:36,520 Speaker 1: would Banks that were receiving live ard payments would expect 136 00:08:36,559 --> 00:08:40,199 Speaker 1: to see more and UH that would not be accounted 137 00:08:40,240 --> 00:08:42,480 Speaker 1: for in an index based on treasury bill So there 138 00:08:42,520 --> 00:08:47,520 Speaker 1: was a demand for an index. It had to be 139 00:08:47,559 --> 00:08:51,679 Speaker 1: based on a survey. They would survey. The survey got 140 00:08:51,720 --> 00:08:56,080 Speaker 1: up to twenty banks. Banks voluntarily participated at the time 141 00:08:56,120 --> 00:08:58,840 Speaker 1: because it was considered prestigious to be in the index, 142 00:08:59,600 --> 00:09:04,000 Speaker 1: and they British Bankers Association would throw out the you know, 143 00:09:04,360 --> 00:09:08,000 Speaker 1: when it got up to when it was sixteen banks, 144 00:09:08,000 --> 00:09:10,520 Speaker 1: they would throw out the top four and the bottom four. 145 00:09:10,840 --> 00:09:13,560 Speaker 1: They were pulled each morning at eleven o'clock London time, 146 00:09:13,960 --> 00:09:16,439 Speaker 1: throughout the top four, the bottom four average, the eight 147 00:09:16,520 --> 00:09:20,720 Speaker 1: that remained round to five decimal places and that's US 148 00:09:20,800 --> 00:09:24,199 Speaker 1: dollar libar that day in one month, two month, three months, 149 00:09:25,040 --> 00:09:27,240 Speaker 1: four or five, six, and so on up to twelve months. 150 00:09:28,440 --> 00:09:32,400 Speaker 1: So it's kind of like how they measure gymnastics or 151 00:09:32,480 --> 00:09:35,280 Speaker 1: ice skating at the Olympics and they throw out the 152 00:09:35,360 --> 00:09:38,240 Speaker 1: Russian judge and they throw out the US judge so 153 00:09:38,400 --> 00:09:42,040 Speaker 1: that they skew unscrew the polls, and then everyone else 154 00:09:42,080 --> 00:09:44,840 Speaker 1: they get an average. Yeah, and it's also similar and 155 00:09:44,840 --> 00:09:46,640 Speaker 1: that you get to see what in the Olympics. You 156 00:09:46,679 --> 00:09:51,280 Speaker 1: see what each judge rates the performance. Uh. It was 157 00:09:51,320 --> 00:09:53,520 Speaker 1: also out in the open at the time, so you 158 00:09:53,520 --> 00:09:57,000 Speaker 1: could see what right each bank that was in the survey, 159 00:09:57,080 --> 00:09:59,920 Speaker 1: which rate, what rate they posted. We tend to think 160 00:10:00,000 --> 00:10:03,319 Speaker 1: of transparency is being virtuous and good under every circumstance, 161 00:10:03,360 --> 00:10:06,600 Speaker 1: but that was part of that was also a part 162 00:10:06,640 --> 00:10:09,200 Speaker 1: of the problem at the time, because if a bank 163 00:10:09,320 --> 00:10:12,520 Speaker 1: was perceiving that was having funding troubles, it would have 164 00:10:12,559 --> 00:10:14,960 Speaker 1: a self interest not to reveal that to the whole 165 00:10:14,960 --> 00:10:18,680 Speaker 1: world by posting a high rate. There's the question posed 166 00:10:18,760 --> 00:10:21,720 Speaker 1: by the British Bankers Association, if you went to borrow 167 00:10:22,200 --> 00:10:26,160 Speaker 1: without negotiating, what rate do you perceive? And let's say 168 00:10:26,360 --> 00:10:31,199 Speaker 1: in the late nineties during the Asian crisis, a bank 169 00:10:31,280 --> 00:10:35,240 Speaker 1: like d k B or Fujibank was having funding pressures. 170 00:10:35,280 --> 00:10:37,360 Speaker 1: They didn't want to say, oh, well, all right, would 171 00:10:37,360 --> 00:10:39,520 Speaker 1: be very high because nobody wants to lend to us, 172 00:10:39,559 --> 00:10:41,240 Speaker 1: and by the way, we just want everybody to see 173 00:10:41,280 --> 00:11:01,160 Speaker 1: it in this official calculation. So there was a moment 174 00:11:01,640 --> 00:11:04,720 Speaker 1: in um again. I think it was the late nineties 175 00:11:05,000 --> 00:11:10,200 Speaker 1: when library sort of became even more embedded with the 176 00:11:10,240 --> 00:11:13,520 Speaker 1: financial market, and that was when the CME, the Chicago 177 00:11:13,640 --> 00:11:18,000 Speaker 1: Mercantile Exchange decided to use libor instead of a reference 178 00:11:18,120 --> 00:11:22,360 Speaker 1: rate that it had been calculating previously. Why did it 179 00:11:22,440 --> 00:11:26,319 Speaker 1: decide to do that and how did that impact the 180 00:11:26,360 --> 00:11:32,320 Speaker 1: market and librars overall integration with the market. The Chicago 181 00:11:32,360 --> 00:11:37,120 Speaker 1: Mercantile Exchange had a contract UH that it launched shortly 182 00:11:37,160 --> 00:11:43,000 Speaker 1: after the British Bankers Association created libor. The They used 183 00:11:43,000 --> 00:11:44,760 Speaker 1: to have also another index they used to have as 184 00:11:44,760 --> 00:11:47,320 Speaker 1: a commercial paper index, but that also had a lot 185 00:11:47,360 --> 00:11:50,480 Speaker 1: of idiosyncrasies that were attached to it. That made it, 186 00:11:51,200 --> 00:11:54,040 Speaker 1: that made it unhelpful. So they switched to something that 187 00:11:54,040 --> 00:11:58,040 Speaker 1: they call your dollars and euro dollars were based on 188 00:11:58,200 --> 00:12:01,280 Speaker 1: an index that the Chicago More can Till Exchange created 189 00:12:01,760 --> 00:12:05,560 Speaker 1: to try to mimic the mimic library, and it would 190 00:12:05,600 --> 00:12:08,439 Speaker 1: differ from library by a basis point or two. So 191 00:12:08,920 --> 00:12:13,240 Speaker 1: there they would conduct their survey on four times a 192 00:12:13,320 --> 00:12:18,600 Speaker 1: year on the Monday before the third Wednesday of every March, June, September, 193 00:12:18,600 --> 00:12:21,839 Speaker 1: and December. So and it was they would draw from 194 00:12:21,840 --> 00:12:25,240 Speaker 1: a very large panel of banks. It was random. Then 195 00:12:25,400 --> 00:12:29,320 Speaker 1: they would they picked twenty banks, and then they threw 196 00:12:29,320 --> 00:12:32,000 Speaker 1: out the top and the bottom it was anonymous, and 197 00:12:32,000 --> 00:12:34,560 Speaker 1: then they did the whole thing again. They randomized again 198 00:12:34,600 --> 00:12:37,320 Speaker 1: to pick twenty banks, and then they surveyed them. They 199 00:12:37,320 --> 00:12:39,760 Speaker 1: didn't know banks, didn't know who was going to be surveyed, 200 00:12:39,920 --> 00:12:42,440 Speaker 1: and then they would average the results of those of 201 00:12:42,440 --> 00:12:46,680 Speaker 1: those two surveys together. Um it was. It was created 202 00:12:47,160 --> 00:12:49,079 Speaker 1: and in the in the mid eighties by the chief 203 00:12:49,080 --> 00:12:52,040 Speaker 1: economist fred Ar Ditty at the Chicago Mark Until Exchange, 204 00:12:52,040 --> 00:12:56,319 Speaker 1: who who was a beloved character in the futures markets 205 00:12:57,240 --> 00:13:03,720 Speaker 1: by many people, including me, UM and then in ninety 206 00:13:04,120 --> 00:13:08,920 Speaker 1: sex the Chicago more Until Exchange applied to the CFTC 207 00:13:09,520 --> 00:13:14,280 Speaker 1: to switch to using the Official British Bankers Association UH contract. 208 00:13:14,720 --> 00:13:17,559 Speaker 1: They were worried at the time that some competitive competitive 209 00:13:17,559 --> 00:13:23,280 Speaker 1: exchange would create a contract based on Official Library and 210 00:13:23,320 --> 00:13:26,520 Speaker 1: that that might give them an advantage because loans, interest 211 00:13:26,600 --> 00:13:29,920 Speaker 1: rate swaps and so forth we're all tied to the 212 00:13:29,960 --> 00:13:33,320 Speaker 1: Official Library. Talks to us a little bit about that 213 00:13:33,360 --> 00:13:38,240 Speaker 1: sort of network effect. Why in why there are can't 214 00:13:38,240 --> 00:13:41,120 Speaker 1: be or why it's difficult to imagine a world of 215 00:13:41,480 --> 00:13:45,719 Speaker 1: multiple indexes or mortgages and credit cards and all these 216 00:13:45,760 --> 00:13:50,280 Speaker 1: things and they all eventually sort of uh coalesce around one. 217 00:13:50,520 --> 00:13:54,280 Speaker 1: Why does that naturally happen? And uh one sort of 218 00:13:54,320 --> 00:13:57,560 Speaker 1: has to emerge the LIB you know, if there are 219 00:13:57,559 --> 00:14:01,640 Speaker 1: many industries around first to create its noise. For if 220 00:14:01,679 --> 00:14:03,560 Speaker 1: you if you have an interest rate swap and you're 221 00:14:03,600 --> 00:14:08,160 Speaker 1: paying b B a official library, and you're hedging using 222 00:14:08,200 --> 00:14:11,240 Speaker 1: your dollar futures, you have a kind of basis risk there. 223 00:14:11,360 --> 00:14:13,720 Speaker 1: Now you can be trying to be very clever and 224 00:14:13,840 --> 00:14:17,040 Speaker 1: understand the basis risk and make it operate to your advantage. 225 00:14:17,280 --> 00:14:21,240 Speaker 1: People try to do that and then if there are 226 00:14:21,240 --> 00:14:24,200 Speaker 1: many industries floating around, the users of those industries will 227 00:14:24,360 --> 00:14:28,520 Speaker 1: worry that, you know, some whoever is offering them the 228 00:14:28,520 --> 00:14:31,640 Speaker 1: product or some index that they didn't expect, is doing 229 00:14:31,680 --> 00:14:35,560 Speaker 1: this in an unscrupulous way. So if there's a single index, 230 00:14:35,760 --> 00:14:38,720 Speaker 1: then it's the same for everybody. And it's clearly the 231 00:14:38,760 --> 00:14:41,720 Speaker 1: same for everybody. I think it's a healthy thing, just 232 00:14:41,840 --> 00:14:44,360 Speaker 1: not the index of the b B A head. So 233 00:14:44,560 --> 00:14:48,720 Speaker 1: by library has sort of edged out a bunch of 234 00:14:48,720 --> 00:14:51,440 Speaker 1: other rates in the market and sort of is on 235 00:14:51,440 --> 00:14:54,320 Speaker 1: its way to becoming the standard. The CME has just 236 00:14:54,360 --> 00:14:58,520 Speaker 1: adopted it for Euro dollar futures, and that I think 237 00:14:58,760 --> 00:15:02,160 Speaker 1: is when you wrote your very well known letter to 238 00:15:02,240 --> 00:15:06,240 Speaker 1: the CFTC in protest of this move. What did the 239 00:15:06,320 --> 00:15:09,640 Speaker 1: letters say? Yeah, I wrote the letter before they actually 240 00:15:09,960 --> 00:15:12,960 Speaker 1: had permission from the CFTC to make the switch because 241 00:15:12,960 --> 00:15:15,040 Speaker 1: I wanted to stop them from doing it, because I 242 00:15:15,040 --> 00:15:17,920 Speaker 1: thought their survey was much better than the than the 243 00:15:17,960 --> 00:15:22,680 Speaker 1: B B A survey. I argued that there were two 244 00:15:22,720 --> 00:15:26,480 Speaker 1: problems with the b B A index. First, that a 245 00:15:26,560 --> 00:15:30,120 Speaker 1: small number of banks were were selected and the same 246 00:15:30,120 --> 00:15:32,880 Speaker 1: ones were selected again and again. They were all active 247 00:15:32,880 --> 00:15:36,320 Speaker 1: participants in derivatives and that they might move the rate 248 00:15:36,600 --> 00:15:39,520 Speaker 1: to their own advantage, that they might manipulate it. At 249 00:15:39,520 --> 00:15:45,360 Speaker 1: the time, it was unregulated, there were no particular criminal 250 00:15:45,400 --> 00:15:48,920 Speaker 1: penalties for doing this, and all that's changed after after 251 00:15:48,960 --> 00:15:52,720 Speaker 1: the crisis. Um. And then I also argued that a 252 00:15:52,760 --> 00:15:58,560 Speaker 1: bank might try to disguise its funding troubles because it 253 00:15:58,640 --> 00:16:02,080 Speaker 1: was because it didn't want to make them worse by 254 00:16:02,240 --> 00:16:04,640 Speaker 1: posting a high rate. If that's what it truly believed 255 00:16:05,080 --> 00:16:06,800 Speaker 1: in the letter, I just I just dug up the 256 00:16:06,880 --> 00:16:11,440 Speaker 1: letter the other day before I came to see you, 257 00:16:11,920 --> 00:16:15,360 Speaker 1: and I wrote in the letter that you know the 258 00:16:15,360 --> 00:16:18,160 Speaker 1: CME claims that the b b A survey will self 259 00:16:18,200 --> 00:16:21,320 Speaker 1: correct if markets become more volatile. They argue that the 260 00:16:21,320 --> 00:16:24,360 Speaker 1: outstanding notional of instruments tied to b b A fixings 261 00:16:24,440 --> 00:16:28,640 Speaker 1: is enormous, and I wrote, but enormous markets create enormous temptations. 262 00:16:28,960 --> 00:16:31,360 Speaker 1: The CME argument works only to the extent that we 263 00:16:31,440 --> 00:16:34,960 Speaker 1: rely on BBA members to look beyond their self interests. Again, 264 00:16:35,000 --> 00:16:38,680 Speaker 1: without impugning any of the b b A banks, we 265 00:16:38,760 --> 00:16:40,840 Speaker 1: do not consider this to be a sound basis for 266 00:16:40,880 --> 00:16:44,320 Speaker 1: predicting human behavior. So I was a snarky little guy then, 267 00:16:44,480 --> 00:16:49,240 Speaker 1: But well, obviously spot on two. But so in retrospect, 268 00:16:49,760 --> 00:16:54,160 Speaker 1: obviously your argument, we'll get to the manipulation that did occur, 269 00:16:54,280 --> 00:16:57,400 Speaker 1: But in retrospect the issues that you highlighted back then, 270 00:16:57,480 --> 00:17:00,640 Speaker 1: they're like, oh, yeah, it seems obvious the potential for 271 00:17:00,720 --> 00:17:03,600 Speaker 1: manipulation to make trades go one way, and a bank 272 00:17:03,640 --> 00:17:07,120 Speaker 1: facing funding stress isn't going to want to put an 273 00:17:07,119 --> 00:17:10,679 Speaker 1: accurate number on a survey in which the survey is 274 00:17:11,000 --> 00:17:14,480 Speaker 1: not anonymous, So that all seems like obvious in retrospect. 275 00:17:14,880 --> 00:17:18,160 Speaker 1: Why wasn't this a source of concern from the very 276 00:17:18,160 --> 00:17:21,800 Speaker 1: beginning or while? Because? Yeah, why weren't there more worried 277 00:17:21,800 --> 00:17:26,199 Speaker 1: about that? Because it seemed to be working? Uh, it was. 278 00:17:26,760 --> 00:17:30,720 Speaker 1: The derivatives market was growing, that forward rate agreements, which 279 00:17:30,760 --> 00:17:34,080 Speaker 1: are tied to live or were growing. Um, the whole 280 00:17:34,119 --> 00:17:38,160 Speaker 1: market was centered on live ar was expanding to sixteen currencies. 281 00:17:38,640 --> 00:17:42,640 Speaker 1: It's I think you have to wait for something bad 282 00:17:42,720 --> 00:17:45,399 Speaker 1: to happen before you can disrupt a force like that 283 00:17:45,440 --> 00:17:48,520 Speaker 1: sounds like how the world works, and I'm afraid it does. Yeah. 284 00:17:48,640 --> 00:17:51,359 Speaker 1: Did anyone from the c f TC get back to you? Yeah, 285 00:17:52,280 --> 00:17:55,880 Speaker 1: they got back to me. As I recall, they said 286 00:17:55,920 --> 00:17:58,720 Speaker 1: they worked at a daylet it was a business decision, 287 00:17:59,040 --> 00:18:03,359 Speaker 1: and they gave me a sweatshirt. They gave you a sweatshirt. 288 00:18:04,080 --> 00:18:08,480 Speaker 1: Do you still have it? Oh? Man? That that that 289 00:18:08,560 --> 00:18:14,679 Speaker 1: was That was the outcome. Ah, I love that detail. Um. 290 00:18:14,840 --> 00:18:19,600 Speaker 1: So obviously librar continued to grow by the time, you know, 291 00:18:19,760 --> 00:18:22,080 Speaker 1: fast forward a few years, by the time we get 292 00:18:22,160 --> 00:18:26,320 Speaker 1: to the financial crisis and when the Shenanigan started to 293 00:18:26,320 --> 00:18:30,399 Speaker 1: be uncovered. How much of the world credit markets and 294 00:18:30,440 --> 00:18:34,040 Speaker 1: how much was linked then to this one index. You know, 295 00:18:34,200 --> 00:18:37,080 Speaker 1: they say that US dollar libar has a four dred 296 00:18:37,119 --> 00:18:40,960 Speaker 1: and fifty trillion dollar footprint right now. It's probably about 297 00:18:41,000 --> 00:18:42,600 Speaker 1: the same at the time if you count your at 298 00:18:42,600 --> 00:18:47,360 Speaker 1: dollar futures, corporate loans, all loans are tied to live bar. 299 00:18:48,440 --> 00:18:50,879 Speaker 1: This is just dollars and it's probably just as big 300 00:18:51,000 --> 00:18:56,639 Speaker 1: in euros tied to your eye bar um, British poems, yeah, 301 00:18:57,040 --> 00:19:00,080 Speaker 1: Swiss frank and many other currencies at the time. So 302 00:19:00,160 --> 00:19:04,280 Speaker 1: the number safe something. I mean, if you count every 303 00:19:04,320 --> 00:19:06,720 Speaker 1: year at all our futures contract you get to quite 304 00:19:06,880 --> 00:19:10,000 Speaker 1: lofty numbers. I mean adding them all together is is 305 00:19:11,160 --> 00:19:14,480 Speaker 1: in a way kind of buff fishy. But that's that 306 00:19:15,280 --> 00:19:18,240 Speaker 1: it's huge by by any standards of hugeness, it's huge. 307 00:19:19,520 --> 00:19:22,919 Speaker 1: So if we fast forward to two thousand eight or 308 00:19:22,960 --> 00:19:27,080 Speaker 1: two thousand nine, as far as I can remember, the 309 00:19:27,200 --> 00:19:31,000 Speaker 1: charges of liborary manipulation or the rumors of liborary manipulation 310 00:19:31,440 --> 00:19:35,760 Speaker 1: started surfacing in the financial media I think in early 311 00:19:35,800 --> 00:19:38,240 Speaker 1: two thousand nine, and you sort of got a steady 312 00:19:38,320 --> 00:19:43,880 Speaker 1: drip of allegations of certain behavior. What did you think 313 00:19:44,400 --> 00:19:46,720 Speaker 1: in those days watching this where you just sort of 314 00:19:46,760 --> 00:19:52,200 Speaker 1: sat in your office, going, see, I told you so hopefully. Uh, 315 00:19:52,440 --> 00:19:56,280 Speaker 1: in those days I had other things, um problems of 316 00:19:56,320 --> 00:19:59,359 Speaker 1: my own at that moment. There's a key turning point 317 00:19:59,640 --> 00:20:01,879 Speaker 1: in the first quarter of two thousand and eight in 318 00:20:02,040 --> 00:20:05,800 Speaker 1: understanding what happened to Liebor, we have to recognize the 319 00:20:05,880 --> 00:20:08,960 Speaker 1: change in the policy of the Federal Reserve to start 320 00:20:09,000 --> 00:20:12,640 Speaker 1: paying interest on access reserves that banks held at the FED. 321 00:20:13,800 --> 00:20:17,960 Speaker 1: Banks would the starting in in Q one O eight um. 322 00:20:18,000 --> 00:20:21,000 Speaker 1: The Fed would pay at the top of its target 323 00:20:20,880 --> 00:20:23,280 Speaker 1: at at its target rate, and then later at the 324 00:20:23,280 --> 00:20:26,320 Speaker 1: top of its target range money that banks left at 325 00:20:26,359 --> 00:20:30,560 Speaker 1: the fat So why would I lend to another bank 326 00:20:30,680 --> 00:20:32,640 Speaker 1: when I could just leave the money at the Central 327 00:20:32,640 --> 00:20:36,280 Speaker 1: Bank and get a generous interest rate, I wouldn't. So 328 00:20:36,359 --> 00:20:40,440 Speaker 1: as a result of that, library became unhinged to anything 329 00:20:40,440 --> 00:20:43,160 Speaker 1: that was happening in the world. Two thousand seven. It's 330 00:20:43,200 --> 00:20:45,280 Speaker 1: not not to do with the financial crisis. Is just 331 00:20:45,560 --> 00:20:47,920 Speaker 1: a change that Bernanke had planned for a long time 332 00:20:47,920 --> 00:20:52,439 Speaker 1: at the Federal Reserve. So the interbank, the ib and 333 00:20:52,480 --> 00:20:58,800 Speaker 1: the liebar vanished. So it left banks to really guess 334 00:20:59,160 --> 00:21:01,919 Speaker 1: what they might borrow if they were to borrow, even 335 00:21:01,960 --> 00:21:05,000 Speaker 1: though they hadn't borrowed no long time. There's a year's 336 00:21:05,119 --> 00:21:10,080 Speaker 1: roll by. It became, you know, the individuals at the 337 00:21:10,080 --> 00:21:16,920 Speaker 1: banks responsible for submitting the uh libar each day would 338 00:21:16,920 --> 00:21:19,320 Speaker 1: just uh, you know, imagine what they might have done 339 00:21:19,320 --> 00:21:22,320 Speaker 1: if an interbank market still existed, but it didn't exist. 340 00:21:23,160 --> 00:21:26,320 Speaker 1: Talk to us a little bit more about the process 341 00:21:26,400 --> 00:21:29,359 Speaker 1: back when it had existed and then didn't. So the 342 00:21:29,400 --> 00:21:31,960 Speaker 1: survey says, what do you think that you could borrow 343 00:21:32,000 --> 00:21:35,080 Speaker 1: at if you weren't negotiating? What would you be offered at? 344 00:21:35,560 --> 00:21:39,399 Speaker 1: What was the actual process within a generic bank, someone's 345 00:21:39,480 --> 00:21:41,280 Speaker 1: job was to come up with that number. How would 346 00:21:41,280 --> 00:21:43,280 Speaker 1: they have done that? And then how did that change 347 00:21:43,400 --> 00:21:45,919 Speaker 1: once that market disappeared. I can only speak from my 348 00:21:46,000 --> 00:21:48,200 Speaker 1: own bank at the time. We would wait. There was 349 00:21:48,240 --> 00:21:50,840 Speaker 1: a bank called Fujibank that would submit it, and you 350 00:21:50,840 --> 00:21:52,919 Speaker 1: could see their submission, and we would wait and do 351 00:21:53,040 --> 00:21:56,240 Speaker 1: something close to their What they actually did at Fujibank, 352 00:21:56,720 --> 00:22:01,920 Speaker 1: I don't know, but it would. It would pretty much 353 00:22:01,960 --> 00:22:06,520 Speaker 1: be based on at the time on what the overnight 354 00:22:06,600 --> 00:22:11,080 Speaker 1: rate was, plus an expectation for what the overnight rate 355 00:22:11,080 --> 00:22:15,800 Speaker 1: would average over the term because borrowing overnight overnight rolling 356 00:22:15,840 --> 00:22:19,679 Speaker 1: it for ninety days is a substitute for borrowing for 357 00:22:19,800 --> 00:22:23,720 Speaker 1: ninety days at a term rate. So more or less 358 00:22:24,040 --> 00:22:27,560 Speaker 1: be the bank's estimate of what they expected from the 359 00:22:27,600 --> 00:22:31,240 Speaker 1: Federal Reserve over the three month period, and then a 360 00:22:31,240 --> 00:22:34,879 Speaker 1: little bit more because it was the offered side the 361 00:22:34,960 --> 00:22:39,680 Speaker 1: o r. And then if there were some liquidity premium, 362 00:22:39,760 --> 00:22:45,320 Speaker 1: some pressures on term funding, some extra compensation that a 363 00:22:45,359 --> 00:22:47,560 Speaker 1: bank would be willing to pay for having the money 364 00:22:47,600 --> 00:22:50,800 Speaker 1: for three months or six months, then they would tack 365 00:22:50,840 --> 00:22:53,000 Speaker 1: on a basis point or two for that. But it 366 00:22:53,080 --> 00:22:55,800 Speaker 1: was that was actually very small. So it's really just 367 00:22:56,040 --> 00:22:58,240 Speaker 1: what do we think the overnight rate will average during 368 00:22:58,240 --> 00:23:01,840 Speaker 1: this time, um us a little bit for the offered side, 369 00:23:02,040 --> 00:23:04,920 Speaker 1: and that that was how it worked. Could you walk 370 00:23:05,000 --> 00:23:10,000 Speaker 1: us through the exact motivations for manipulating library because and 371 00:23:10,160 --> 00:23:14,240 Speaker 1: and specifically the motivation for manipulating librar higher because I 372 00:23:14,280 --> 00:23:17,600 Speaker 1: think a lot of people will understand that. You know, 373 00:23:18,119 --> 00:23:20,680 Speaker 1: you might low ball the number because you don't want 374 00:23:20,720 --> 00:23:24,560 Speaker 1: to out yourself as having a higher rate of borrowing 375 00:23:24,600 --> 00:23:26,879 Speaker 1: in the inter bank market than some of your other 376 00:23:27,240 --> 00:23:30,520 Speaker 1: bank peers. But why would anyone want to manipulate the 377 00:23:30,640 --> 00:23:33,680 Speaker 1: rate higher? How did that work? Okay? There are two 378 00:23:33,720 --> 00:23:37,639 Speaker 1: classes of manipulation here. The first is if you're receiving 379 00:23:37,760 --> 00:23:41,440 Speaker 1: or making a payment tied to libor, you might if 380 00:23:41,440 --> 00:23:44,199 Speaker 1: you're making a payment, you would like it a little lower. 381 00:23:44,520 --> 00:23:47,440 Speaker 1: If you're receiving a payment tied to live or, you 382 00:23:47,480 --> 00:23:49,800 Speaker 1: would like it to be a little higher. Now, you 383 00:23:49,880 --> 00:23:53,040 Speaker 1: might be making a payment or receiving a payment depending 384 00:23:53,760 --> 00:23:56,720 Speaker 1: most likely tied to an interest rate swap. So in 385 00:23:56,800 --> 00:23:59,439 Speaker 1: an interest rate swap, a bank will pay fixed and 386 00:23:59,480 --> 00:24:04,320 Speaker 1: receive a sequence of payments based on live or or. 387 00:24:04,359 --> 00:24:07,880 Speaker 1: If it's um receiving a fixed rate, it will make 388 00:24:07,880 --> 00:24:11,480 Speaker 1: payments tied to live or. So it's completely symmetrical that way. 389 00:24:11,520 --> 00:24:13,960 Speaker 1: There may be days when a bank has a big 390 00:24:14,320 --> 00:24:17,200 Speaker 1: live or fixing on an interest rate swap where it's 391 00:24:17,200 --> 00:24:19,719 Speaker 1: receiving fixed and would like it to be a little higher, 392 00:24:19,840 --> 00:24:21,760 Speaker 1: or days when it's paying fixed and would like it 393 00:24:21,800 --> 00:24:24,639 Speaker 1: to be a little lower. That's that's kind of a 394 00:24:24,680 --> 00:24:29,720 Speaker 1: micro manipulation. And then there's the other there's there's the 395 00:24:29,800 --> 00:24:34,000 Speaker 1: signaling effect where it would like to create lower It 396 00:24:34,080 --> 00:24:36,320 Speaker 1: doesn't want to stand out from the crowd if there's 397 00:24:36,400 --> 00:24:41,720 Speaker 1: suspicion that it has um funding problems. The so called 398 00:24:41,880 --> 00:24:45,240 Speaker 1: Live War scandal was the first kind of manipulation where 399 00:24:45,240 --> 00:24:51,040 Speaker 1: banks would presumably change their rate based on what was 400 00:24:51,080 --> 00:25:09,800 Speaker 1: going to happen on their self interest at that day. Now, 401 00:25:10,000 --> 00:25:12,760 Speaker 1: you mentioned in the beginning, I think you said they 402 00:25:12,760 --> 00:25:16,560 Speaker 1: pulled twenty banks. They lop off the top four and 403 00:25:16,760 --> 00:25:20,240 Speaker 1: they lop off the bottom four. So that makes it difficult, 404 00:25:20,400 --> 00:25:24,880 Speaker 1: of course for anyone bank to manipulate uh the underlying 405 00:25:24,920 --> 00:25:27,840 Speaker 1: price because you could post something extreme in one direction, 406 00:25:27,880 --> 00:25:30,280 Speaker 1: but they'll just lop it off. This gets to where 407 00:25:30,280 --> 00:25:35,200 Speaker 1: there must have been and there was an element of collusion. Okay, 408 00:25:35,920 --> 00:25:41,560 Speaker 1: I don't believe I agree with your your statement that 409 00:25:41,600 --> 00:25:44,360 Speaker 1: it's hard to move the rate by very much. So 410 00:25:44,640 --> 00:25:49,160 Speaker 1: you know, a bank like Barclays might move the rate 411 00:25:49,240 --> 00:25:52,240 Speaker 1: by let's say eight basis points, and they can still 412 00:25:52,280 --> 00:25:56,040 Speaker 1: not be lopped off. Let's take the case where they're 413 00:25:56,800 --> 00:25:59,080 Speaker 1: Let's suppose that they're able to move the rate by 414 00:25:59,080 --> 00:26:02,800 Speaker 1: one basis point, right, I think that's possible acting on 415 00:26:02,840 --> 00:26:07,200 Speaker 1: their own. Let's say that they're receiving a five billion 416 00:26:07,359 --> 00:26:09,960 Speaker 1: dollars set. They're receiving that, and they can make the 417 00:26:10,600 --> 00:26:14,280 Speaker 1: dollar reset for three months, So that's twenty one basis 418 00:26:14,280 --> 00:26:20,040 Speaker 1: point on a million dollars is so in five million, 419 00:26:20,280 --> 00:26:22,679 Speaker 1: it's a hundred and twenty five thousand dollars. So if 420 00:26:22,680 --> 00:26:24,640 Speaker 1: they can move it up by a basis point, which 421 00:26:24,680 --> 00:26:27,680 Speaker 1: would be heroic for them to do that, they could 422 00:26:27,760 --> 00:26:30,840 Speaker 1: Yet they could make a hundred and twenty five dollars, 423 00:26:31,680 --> 00:26:36,879 Speaker 1: So you know, this has been called Rolling Stone called 424 00:26:36,880 --> 00:26:41,520 Speaker 1: this the scandal of all scandals. Some UH publications called 425 00:26:41,560 --> 00:26:47,240 Speaker 1: this the greatest crime of the twentie century. I don't 426 00:26:47,240 --> 00:26:49,320 Speaker 1: know what the greatest crime of the twentieth century is, 427 00:26:49,320 --> 00:26:51,200 Speaker 1: but I don't think it's this. I mean, I think 428 00:26:51,200 --> 00:26:54,280 Speaker 1: it's small change that the manipulation that they were able 429 00:26:54,320 --> 00:26:58,919 Speaker 1: to affect and collusion, you know, I don't believe that 430 00:26:58,960 --> 00:27:01,199 Speaker 1: there was collusion. I don't know that, but would be 431 00:27:01,280 --> 00:27:04,000 Speaker 1: very hard. If any collusion were to happen, it would 432 00:27:04,000 --> 00:27:07,639 Speaker 1: be orchestrated by the brokers. Okay, eye cap has been 433 00:27:07,680 --> 00:27:12,560 Speaker 1: implicated in this, but since banks have competing interests every day, 434 00:27:12,440 --> 00:27:15,000 Speaker 1: the idea that they all want a high set on 435 00:27:15,040 --> 00:27:19,919 Speaker 1: this particular day, it is unlikely. Um So, you know, 436 00:27:20,359 --> 00:27:23,359 Speaker 1: if under a lot of money, but it's not not 437 00:27:23,440 --> 00:27:27,520 Speaker 1: a lot of money to someone in trading gigantic swamps book, 438 00:27:27,640 --> 00:27:30,760 Speaker 1: So I think, uh, I think it was kind of 439 00:27:30,760 --> 00:27:33,639 Speaker 1: acute and for them, acute and small time crime. What 440 00:27:33,800 --> 00:27:37,800 Speaker 1: made this really scandalous? First couple, for a couple of reasons. 441 00:27:38,080 --> 00:27:44,000 Speaker 1: It is scandalous. First, the email traffic is is really embarrassing, 442 00:27:44,160 --> 00:27:49,560 Speaker 1: the famous I'm opening a bottle of Bolinger Champagne emails 443 00:27:49,600 --> 00:27:53,359 Speaker 1: and that sort of thing. And he it was actually 444 00:27:53,400 --> 00:27:56,320 Speaker 1: Cure Curry that they were getting once his credit card 445 00:27:56,400 --> 00:27:59,560 Speaker 1: was retired. And then he wrote anything for you, big boy. 446 00:28:00,400 --> 00:28:04,840 Speaker 1: And I also believe, you know, if I think a 447 00:28:04,880 --> 00:28:07,359 Speaker 1: lot of this was just bluster, I'm not sure. You know, 448 00:28:07,720 --> 00:28:11,360 Speaker 1: I'm not sure that as much happened as the broker 449 00:28:11,440 --> 00:28:15,000 Speaker 1: might say. You know, I'll arrange this for you, big boy. 450 00:28:15,200 --> 00:28:17,320 Speaker 1: And then not do it, and then if the rate 451 00:28:17,359 --> 00:28:19,280 Speaker 1: went the way that they were hoping, they would take 452 00:28:19,320 --> 00:28:21,159 Speaker 1: credit for it. I think there was plenty of that 453 00:28:21,280 --> 00:28:24,720 Speaker 1: going on. This gets to one of my very my 454 00:28:24,880 --> 00:28:29,000 Speaker 1: side issues that has almost nothing to do with finance 455 00:28:29,119 --> 00:28:32,080 Speaker 1: per se, which is that all of our emails, in 456 00:28:32,200 --> 00:28:36,040 Speaker 1: texts and direct messages look a lot worse than reality 457 00:28:36,080 --> 00:28:39,520 Speaker 1: because people just talk and they blust her, they b 458 00:28:39,800 --> 00:28:42,280 Speaker 1: s and they brag, and then if any of us 459 00:28:42,640 --> 00:28:45,360 Speaker 1: were to have all of our private correspondence is dragged 460 00:28:45,400 --> 00:28:47,600 Speaker 1: out in a court of law or in the media, 461 00:28:47,640 --> 00:28:51,360 Speaker 1: it would look pretty terrible. That's just a general belief 462 00:28:51,680 --> 00:28:55,920 Speaker 1: beyond any sort of uh, you know, fixing of an index. Yeah, 463 00:28:55,960 --> 00:28:58,080 Speaker 1: and I think people are more careful as a result 464 00:28:58,120 --> 00:29:01,520 Speaker 1: of this scandal because it blew up. You know, part 465 00:29:01,560 --> 00:29:05,800 Speaker 1: of there's a second scandal are there's a lot of 466 00:29:05,800 --> 00:29:08,959 Speaker 1: blame to go around here, and the other scandal is 467 00:29:09,640 --> 00:29:13,080 Speaker 1: paying interest on reserves for the Central Bank and then 468 00:29:13,120 --> 00:29:15,440 Speaker 1: not doing anything to fix live lary. This should have 469 00:29:15,480 --> 00:29:20,040 Speaker 1: been done in two thousand seven. This was because how 470 00:29:20,080 --> 00:29:23,040 Speaker 1: can you continue to use as a centerpiece of three 471 00:29:23,040 --> 00:29:28,080 Speaker 1: month right that doesn't exist anymore? So if the fundamental 472 00:29:28,200 --> 00:29:32,800 Speaker 1: process of setting library via survey just continued on even 473 00:29:32,920 --> 00:29:36,640 Speaker 1: after the interbank market de facto ended with the payment 474 00:29:36,680 --> 00:29:40,479 Speaker 1: of interest on access reserves. Is there anything visible in 475 00:29:40,520 --> 00:29:44,600 Speaker 1: the data that shows weirdness, Like did the dispersion of 476 00:29:45,080 --> 00:29:50,320 Speaker 1: inputs start to change because the numbers became more fictitious 477 00:29:50,320 --> 00:29:51,440 Speaker 1: and made up? Like there' is there a way to 478 00:29:51,480 --> 00:29:53,560 Speaker 1: sort of if you look at it forensically, could you 479 00:29:53,640 --> 00:29:56,760 Speaker 1: see something happened at that switch? I don't think so. 480 00:29:56,880 --> 00:29:59,120 Speaker 1: You know, the groups were moving in a pack so 481 00:29:59,200 --> 00:30:03,959 Speaker 1: they could see each other. Um, I think you know 482 00:30:04,280 --> 00:30:09,480 Speaker 1: FED funds the overnight market, the domestic market also basically vanished, 483 00:30:09,880 --> 00:30:12,080 Speaker 1: so there's still a FED funds index. You may wonder 484 00:30:12,320 --> 00:30:15,680 Speaker 1: who which banks are lending to each other overnight? And 485 00:30:15,720 --> 00:30:19,120 Speaker 1: that became the only banks that would lend in the 486 00:30:19,160 --> 00:30:23,400 Speaker 1: inter bank market for FED funds became federal home loan 487 00:30:23,480 --> 00:30:27,760 Speaker 1: banks that offered reserve pulling services for their member banks 488 00:30:28,000 --> 00:30:30,440 Speaker 1: that didn't have access to the Federal reserve, So it 489 00:30:30,520 --> 00:30:32,880 Speaker 1: just became a very small market. They couldn't lend at 490 00:30:32,880 --> 00:30:36,720 Speaker 1: the FED, so they would they would lend to Japanese 491 00:30:36,760 --> 00:30:39,400 Speaker 1: banks that didn't have to pay deposit insurance. That would 492 00:30:39,400 --> 00:30:42,880 Speaker 1: turn around and put the reserves at the at at 493 00:30:43,040 --> 00:30:46,239 Speaker 1: at the Federal Reserve. So it was it became a 494 00:30:46,280 --> 00:30:50,200 Speaker 1: tiny market of about fifty billion dollars overnight after the 495 00:30:50,240 --> 00:30:53,560 Speaker 1: first quarter of two thousand and eight. So I think 496 00:30:53,720 --> 00:31:00,120 Speaker 1: the scandal became a maybe a catalyst too. Oh were 497 00:31:00,200 --> 00:31:03,320 Speaker 1: Hall libar, But it had to be done eventually anyway, 498 00:31:03,320 --> 00:31:04,680 Speaker 1: and I think it should have been done a long 499 00:31:04,720 --> 00:31:07,320 Speaker 1: time ago. I mean, from what I remember, there there 500 00:31:07,480 --> 00:31:10,440 Speaker 1: was some academic research, I think from two thousand and 501 00:31:10,480 --> 00:31:13,920 Speaker 1: eight where they did look into LIEBR submissions, and I 502 00:31:13,960 --> 00:31:18,800 Speaker 1: think they did find some sketchiness. They're like some banks 503 00:31:18,840 --> 00:31:23,120 Speaker 1: seem more inclined to quote higher than others um and 504 00:31:23,320 --> 00:31:25,560 Speaker 1: it never came to a firm conclusion, but it sort 505 00:31:25,600 --> 00:31:29,440 Speaker 1: of kicked off a lot of discussion. I was just wondering, 506 00:31:29,880 --> 00:31:33,480 Speaker 1: as this came to light and as the allegations are 507 00:31:33,520 --> 00:31:36,440 Speaker 1: sort of flying around post two thousand nine, were you 508 00:31:36,520 --> 00:31:39,720 Speaker 1: surprised at all by the reaction of the British Bankers 509 00:31:39,760 --> 00:31:45,320 Speaker 1: Association because they defended the libar process to the very end. 510 00:31:46,800 --> 00:31:48,920 Speaker 1: Maybe you know, that was a prestigious thing for them, 511 00:31:48,920 --> 00:31:51,320 Speaker 1: it was what they were known for, but they there 512 00:31:51,400 --> 00:31:55,360 Speaker 1: was not a role for them, um post not post crisis, 513 00:31:55,400 --> 00:31:59,920 Speaker 1: but post in dollars post the first quarter of two 514 00:32:00,000 --> 00:32:05,200 Speaker 1: Alston tonight. Um, So I guess it's I guess it 515 00:32:05,200 --> 00:32:07,240 Speaker 1: shouldn't come as a surprise that people want to hang 516 00:32:07,280 --> 00:32:11,160 Speaker 1: onto their power. So talk to us a little bit 517 00:32:11,200 --> 00:32:14,800 Speaker 1: more about the other form of manipulation in that significance. So, 518 00:32:14,840 --> 00:32:18,080 Speaker 1: as you mentioned, there was the attempts to adjust the 519 00:32:18,240 --> 00:32:21,120 Speaker 1: rate for perhaps to gain a little bit of an 520 00:32:21,200 --> 00:32:23,920 Speaker 1: edge on a trade, or maybe to convince a client 521 00:32:24,000 --> 00:32:27,320 Speaker 1: that you've done something really big for them. But as 522 00:32:27,360 --> 00:32:30,719 Speaker 1: you put it, it is a scandal, but probably not 523 00:32:30,840 --> 00:32:34,680 Speaker 1: the greatest scandal of the century or the biggest crime 524 00:32:34,760 --> 00:32:38,040 Speaker 1: or the biggest swindle ever. But what about this other 525 00:32:38,160 --> 00:32:42,120 Speaker 1: part of the significance, or the degree to which banks 526 00:32:42,200 --> 00:32:47,040 Speaker 1: disguise their funding weakness just by submitting false bits. Yeah, 527 00:32:47,360 --> 00:32:50,280 Speaker 1: I'll say one one thing on behalf of the banks. 528 00:32:51,080 --> 00:32:55,800 Speaker 1: Let's let's consider September two thousand and eight, on the 529 00:32:55,880 --> 00:33:00,800 Speaker 1: Monday when Lehman went into administration. Okay, the question becomes, 530 00:33:01,240 --> 00:33:05,640 Speaker 1: if you were to go and borrow UH for three 531 00:33:05,640 --> 00:33:08,440 Speaker 1: months six months from another bank without negotiating, what right 532 00:33:08,480 --> 00:33:11,720 Speaker 1: would you get? Now? On that day, Goldman Sachs and 533 00:33:11,760 --> 00:33:14,920 Speaker 1: Deutsche Bank wouldn't settle spot for in exchange with each other. 534 00:33:15,560 --> 00:33:17,640 Speaker 1: So if you were to call another bank and asked 535 00:33:17,640 --> 00:33:20,400 Speaker 1: to borrow for three months and not negotiate, the answer 536 00:33:20,400 --> 00:33:24,840 Speaker 1: would be infinity. Okay, there's no responsible thing to do 537 00:33:25,040 --> 00:33:29,520 Speaker 1: because this in this question that you're being asked is 538 00:33:29,560 --> 00:33:32,640 Speaker 1: posed for a different environment, for a different background. So 539 00:33:32,680 --> 00:33:35,840 Speaker 1: the question, just the grammar of the question doesn't make 540 00:33:35,840 --> 00:33:40,880 Speaker 1: any sense, and you have to give something, so, you know, makeup. 541 00:33:41,000 --> 00:33:44,680 Speaker 1: If they put you a million percent or a thousand percent, 542 00:33:44,800 --> 00:33:46,640 Speaker 1: then they would have blown up all the derivatives of 543 00:33:46,640 --> 00:33:48,480 Speaker 1: the world and all the home mortgages and all the 544 00:33:48,480 --> 00:33:53,400 Speaker 1: floating right does so they just put something. Famously, Barclays 545 00:33:53,600 --> 00:33:56,640 Speaker 1: was putting a higher rate in dollars than other banks, 546 00:33:56,760 --> 00:33:59,080 Speaker 1: and Paul Tucker at the Bank of England told them 547 00:33:59,120 --> 00:34:01,920 Speaker 1: to lay off a little bit because you're you're freaking 548 00:34:01,960 --> 00:34:06,280 Speaker 1: people out. I'm paraphrasing, and you know he was criticized 549 00:34:06,320 --> 00:34:09,560 Speaker 1: for that, but you know, in the context of the time, 550 00:34:09,600 --> 00:34:11,399 Speaker 1: it was sort of a grown up thing to do 551 00:34:11,640 --> 00:34:15,960 Speaker 1: because nobody's the whole thing is is divorced from any 552 00:34:16,040 --> 00:34:19,759 Speaker 1: kind of reality. People have to muddle through because the 553 00:34:19,760 --> 00:34:25,640 Speaker 1: index was not constructed for this environment. So I'm not, 554 00:34:25,880 --> 00:34:28,160 Speaker 1: you know, sure what else to do. Well, it just 555 00:34:28,200 --> 00:34:32,920 Speaker 1: to be clear, in mid September, it's not like there 556 00:34:32,960 --> 00:34:34,799 Speaker 1: was a lot of mystery that the banks were under 557 00:34:34,800 --> 00:34:37,600 Speaker 1: a lot of stress. So even if to the degree 558 00:34:37,920 --> 00:34:40,960 Speaker 1: that they may have been making things up, it's not 559 00:34:41,040 --> 00:34:43,520 Speaker 1: like people were under some illusion that they were all 560 00:34:43,560 --> 00:34:48,080 Speaker 1: in great health, right I I I don't think it 561 00:34:48,120 --> 00:34:51,440 Speaker 1: was shocking. I think looking at the details of the 562 00:34:51,520 --> 00:34:54,160 Speaker 1: live or submissions and trying to read anything into that 563 00:34:54,480 --> 00:34:59,080 Speaker 1: was a hopeless exercise. So it would probably be overegging 564 00:34:59,160 --> 00:35:02,360 Speaker 1: it to say that actually giving the banks a degree 565 00:35:02,480 --> 00:35:07,360 Speaker 1: of control over their self reported borrowing rates might have 566 00:35:07,400 --> 00:35:09,520 Speaker 1: been a good thing in September two tho eight, or 567 00:35:09,520 --> 00:35:11,560 Speaker 1: at least gave them a little bit of leeway. But 568 00:35:12,040 --> 00:35:14,320 Speaker 1: I think that's a good segue maybe to talk about 569 00:35:14,560 --> 00:35:18,319 Speaker 1: the transition away from ybor Um. And I think the 570 00:35:18,360 --> 00:35:22,040 Speaker 1: effort is mostly to again move away from this self 571 00:35:22,040 --> 00:35:25,960 Speaker 1: reported survey and go back to a reference rate that's 572 00:35:26,000 --> 00:35:31,279 Speaker 1: based on actual transactions. What do you think about that move? Yeah, 573 00:35:31,320 --> 00:35:33,799 Speaker 1: I think the move to SOFA which we have in 574 00:35:33,840 --> 00:35:37,440 Speaker 1: the United States is the right one. It's based on 575 00:35:37,520 --> 00:35:44,319 Speaker 1: actual transactions secured overnight financing. The and we should point 576 00:35:44,320 --> 00:35:47,040 Speaker 1: out in other currencies the move has already been made 577 00:35:47,280 --> 00:35:51,680 Speaker 1: in Australia to bank bills, in Canada to see daru, 578 00:35:52,760 --> 00:35:57,719 Speaker 1: the New Zealand Danish krona, they've all made the transition 579 00:35:57,800 --> 00:36:01,560 Speaker 1: years ago to overnight secured right. And in Euros the 580 00:36:01,600 --> 00:36:06,120 Speaker 1: move the equivalent to SOFAR is something called esther, the 581 00:36:06,160 --> 00:36:12,600 Speaker 1: Euro short term interest rate UM, the and the E 582 00:36:12,760 --> 00:36:16,920 Speaker 1: and esther is the euro symbol. And already the overnight 583 00:36:17,440 --> 00:36:21,360 Speaker 1: interest rate called the one A in Euros has switched 584 00:36:21,400 --> 00:36:24,680 Speaker 1: to ESTHER plus a spread and that's produced by the 585 00:36:24,680 --> 00:36:31,440 Speaker 1: ECB every day. UM. The SOFA is based on secured 586 00:36:31,480 --> 00:36:36,600 Speaker 1: overnight financing. So each day at eight o'clock UM, the 587 00:36:36,600 --> 00:36:42,239 Speaker 1: PO Reserve publishes the average repo rate or secured financing 588 00:36:42,440 --> 00:36:45,319 Speaker 1: that was reported to them from the previous day, and 589 00:36:45,520 --> 00:36:49,600 Speaker 1: it's a it's a volume weighted median. So you throw 590 00:36:49,600 --> 00:36:51,480 Speaker 1: out all the top and all the bottom, and look 591 00:36:51,520 --> 00:36:54,680 Speaker 1: what's in the middle, and uh so it's it's an 592 00:36:54,680 --> 00:36:57,680 Speaker 1: overnight rate. And then the the issue that the market 593 00:36:57,719 --> 00:37:00,160 Speaker 1: has to confront is how to turn an overnight right 594 00:37:00,200 --> 00:37:02,399 Speaker 1: into a three month rate or a six month rate 595 00:37:02,960 --> 00:37:07,800 Speaker 1: in order to create new contracts and also to switch 596 00:37:07,880 --> 00:37:14,319 Speaker 1: over all the legacy contracts. Okay, uh, Richard, we're going 597 00:37:14,360 --> 00:37:17,760 Speaker 1: to stop it there, because we're going to devote at 598 00:37:17,840 --> 00:37:21,120 Speaker 1: least I think two more episodes into really delving into 599 00:37:21,200 --> 00:37:25,600 Speaker 1: the technicalities of sofer and other replacement rates for libor. 600 00:37:25,840 --> 00:37:28,120 Speaker 1: But thank you so much for coming on. That was 601 00:37:28,280 --> 00:37:32,000 Speaker 1: a really fantastic conversation. Thanks, thanks, Thanks Trisy, It's a pleasure. 602 00:37:38,480 --> 00:37:41,120 Speaker 1: So Joe, do you feel do you feel more up 603 00:37:41,160 --> 00:37:44,680 Speaker 1: to speed on the Librar series? Yeah? That was actually 604 00:37:44,840 --> 00:37:49,279 Speaker 1: incredibly helpful. Um I had only the most vague outlined, 605 00:37:49,880 --> 00:37:53,439 Speaker 1: but just really walking through the mechanics of how they 606 00:37:53,560 --> 00:37:56,759 Speaker 1: constructed it, how the manipulation worked, a degree of it, 607 00:37:57,200 --> 00:38:02,240 Speaker 1: why the world credit markets less around it, I found. Uh. 608 00:38:02,320 --> 00:38:04,600 Speaker 1: I feel like as we continue with this series, I 609 00:38:04,719 --> 00:38:06,759 Speaker 1: feel a little bit more on firmer footing than I 610 00:38:06,760 --> 00:38:09,720 Speaker 1: did a little while ago. Yeah, and I think Richard 611 00:38:09,800 --> 00:38:12,520 Speaker 1: is really good at getting to the nuance of a 612 00:38:12,520 --> 00:38:16,919 Speaker 1: lot of this topic, like the differences in manipulation, why 613 00:38:17,000 --> 00:38:20,840 Speaker 1: people did what they did, and also the degree to 614 00:38:20,960 --> 00:38:23,920 Speaker 1: which it was a scandal or not, because, of course, 615 00:38:24,480 --> 00:38:28,080 Speaker 1: if you're manipulating the reference rate for trillions of dollars 616 00:38:28,080 --> 00:38:30,920 Speaker 1: worth of financial assets one basis point or another. It 617 00:38:31,040 --> 00:38:33,320 Speaker 1: is going to have an impact on the overall market, 618 00:38:33,680 --> 00:38:38,839 Speaker 1: but your actual profit from that move is probably not 619 00:38:38,920 --> 00:38:43,480 Speaker 1: going to be that huge. Yeah, exactly right, And uh, 620 00:38:43,520 --> 00:38:46,440 Speaker 1: it's great to hear from someone who, like ten years 621 00:38:46,960 --> 00:38:52,000 Speaker 1: before everyone to agree or recognize that the system was flawed. 622 00:38:52,280 --> 00:38:54,480 Speaker 1: Seemed to nail it exactly. It's only too bad that 623 00:38:54,520 --> 00:38:57,160 Speaker 1: he didn't keep that sweatshirt. Yeah, it sort of speaks 624 00:38:57,200 --> 00:39:01,080 Speaker 1: to what's the word I'm looking for, systemic complacency. I 625 00:39:01,120 --> 00:39:05,319 Speaker 1: think people always knew that there was a possibility a 626 00:39:05,480 --> 00:39:09,720 Speaker 1: survey of self reported borrowing costs from the banks could maybe, 627 00:39:09,960 --> 00:39:13,640 Speaker 1: uh not necessarily reflect reality all the time, and people 628 00:39:13,760 --> 00:39:17,439 Speaker 1: chose to overlook it because libor was easy for them, 629 00:39:17,520 --> 00:39:20,600 Speaker 1: It was standardized at that point, and frankly, it was 630 00:39:20,640 --> 00:39:24,120 Speaker 1: profitable and linked to lots of different financial instruments, from 631 00:39:24,200 --> 00:39:28,719 Speaker 1: euro dollars to interest rate swaps. Yeah, exactly right. All right, 632 00:39:28,719 --> 00:39:31,120 Speaker 1: should we leave it there? Yeah, we have lots more 633 00:39:31,200 --> 00:39:35,120 Speaker 1: to talk about in our next episode. This has been 634 00:39:35,239 --> 00:39:38,520 Speaker 1: another edition of the All Thoughts podcast. I'm Tracy Alloway. 635 00:39:38,640 --> 00:39:42,000 Speaker 1: You can follow me on Twitter at Tracy Alloway. I'm 636 00:39:42,080 --> 00:39:44,440 Speaker 1: Joe Why Isn't All? You can follow me on Twitter 637 00:39:44,560 --> 00:39:48,600 Speaker 1: at the Stalwarts, and you can follow our producer on Twitter, 638 00:39:48,680 --> 00:39:52,520 Speaker 1: Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg 639 00:39:52,560 --> 00:39:57,560 Speaker 1: Head of Podcasts, Francesca Levy at Francesca Today, and check 640 00:39:57,600 --> 00:40:00,080 Speaker 1: out all of our podcast at Bloomberg under the A 641 00:40:00,160 --> 00:40:02,520 Speaker 1: handle at podcasts. Thanks for listening.