WEBVTT - Meet the Man Who Blew the Whistle on LIBOR 0:00:11.080 --> 0:00:14.600 Hello, and welcome to another episode of the Odd Thoughts podcast. 0:00:14.720 --> 0:00:19.639 I'm Tracy Allaway and I'm Joe. Wisn't all so, Joe. 0:00:19.760 --> 0:00:23.560 We're finally doing it. We're finally doing our live ard series. 0:00:24.920 --> 0:00:28.000 Uh yeah, we've been talking about this for a while, 0:00:28.320 --> 0:00:33.600 the idea of doing a big series on librar, what 0:00:33.760 --> 0:00:36.960 happened to it, what it was, what his state is now, 0:00:37.159 --> 0:00:41.239 where it's going, and uh, we're going to kick it off. Yep. 0:00:41.440 --> 0:00:43.960 This is the first of those episodes. So just as 0:00:44.000 --> 0:00:47.760 an introduction, let's talk about what libor is. Librar is 0:00:47.800 --> 0:00:52.240 the London Interbank Offered rate, and it is, as you mentioned, Joe, 0:00:52.320 --> 0:00:56.400 in a state of transition. Just for background, this is 0:00:56.560 --> 0:01:00.600 basically the reference rate that governs trillions of dollars worth 0:01:00.600 --> 0:01:03.040 of asset prices. So, for instance, if you sell a 0:01:03.040 --> 0:01:05.640 bond in the market, it will be priced off lib 0:01:05.800 --> 0:01:08.840 or um, so whatever the inter bank offered rate is 0:01:08.959 --> 0:01:12.000 plus an additional yield. Same thing if you sell alone 0:01:12.640 --> 0:01:16.679 home mortgages priced off lib or. Basically, the financial system 0:01:16.800 --> 0:01:20.479 has for many many years run on library and that 0:01:20.600 --> 0:01:22.800 is a big deal because we are supposed to be 0:01:22.840 --> 0:01:27.800 moving away from that particular reference rate, right, So this 0:01:27.880 --> 0:01:30.680 is not a topic that I know particularly well. I 0:01:30.760 --> 0:01:34.600 know about the centrality of the rate. I know that 0:01:34.640 --> 0:01:38.480 there is an effort afoot to move all of these 0:01:38.600 --> 0:01:42.919 various offerings that currently index in some way to libel 0:01:43.120 --> 0:01:45.880 onto something new, which will get to in this series. 0:01:46.520 --> 0:01:49.640 And I know that around the time of the crisis 0:01:50.000 --> 0:01:52.080 there was a manipulation of this price and that that 0:01:52.160 --> 0:01:54.720 was a major scandal, and that the way the price 0:01:54.800 --> 0:01:59.240 is set and measured opened itself to all kinds of shenanigans. 0:01:59.280 --> 0:02:02.320 But honestly, I don't know much more about it than that. 0:02:02.400 --> 0:02:04.280 I don't know much about its history. I don't know 0:02:04.320 --> 0:02:09.680 the degree to which the manipulation really affected things. I 0:02:09.720 --> 0:02:12.600 don't know why it's so difficult to change, and I'm 0:02:12.720 --> 0:02:16.160 very much looking forward to learning more as we embark 0:02:16.240 --> 0:02:18.720 on this series, because although I don't know very much 0:02:18.760 --> 0:02:21.080 about it, I get the sense that this is extremely 0:02:21.080 --> 0:02:24.480 important and that people in credit market it's one of 0:02:24.560 --> 0:02:27.360 the big things that is going to affect their industry, 0:02:27.360 --> 0:02:30.960 and that they're all watching absolutely And you've set the 0:02:30.960 --> 0:02:35.200 scene perfectly, and we are actually going to start with 0:02:35.240 --> 0:02:37.840 a discussion about what lib or is, how it came 0:02:37.840 --> 0:02:41.880 into being and of course the manipulation scandal that happened 0:02:41.960 --> 0:02:45.600 after the financial crisis. So it's a good place to start. 0:02:46.040 --> 0:02:49.320 And our guest is actually the perfect guests to talk 0:02:49.360 --> 0:02:52.760 about this. Uh. He's basically been a Cassandra when it 0:02:52.800 --> 0:02:56.560 comes to warning about the potential for banks to do 0:02:56.800 --> 0:03:00.960 sketchy stuff with lib or. His name is Richard Rob. 0:03:01.120 --> 0:03:04.320 He's currently the CEO of the hedge fund Christoffers and 0:03:04.400 --> 0:03:08.680 Rob also a professor at Columbia and many many years ago, 0:03:09.000 --> 0:03:12.720 he was actually a rates trader at d KB Financial 0:03:12.800 --> 0:03:16.000 in New York, and he famously wrote a letter to 0:03:16.080 --> 0:03:19.760 one of the regulators, the CFDC, warning of the potential 0:03:19.880 --> 0:03:23.640 for library manipulation. And this was way back in I 0:03:23.680 --> 0:03:28.320 think the late So really the perfect person to discuss this. 0:03:29.560 --> 0:03:33.960 I can't wait. I can't wait to learn all about it. Excellent, Richard, 0:03:34.320 --> 0:03:36.840 thank you so much for coming on. Great to be here, 0:03:37.480 --> 0:03:41.040 so I guess too. Just to begin with, I'm curious, 0:03:41.080 --> 0:03:43.600 what was it like being a rates trader in the nineties. 0:03:43.720 --> 0:03:45.640 Quite a lot happening back then when it comes to 0:03:45.680 --> 0:03:51.160 interest rates. Oh, it was so much fun. Um the 0:03:51.200 --> 0:03:54.200 interest rates would move ten fifteen bases points. Today the 0:03:54.200 --> 0:03:56.960 interbank market was very active. You know, the ib and 0:03:57.080 --> 0:04:00.560 lib or stands for interbank. So banks would and borrow 0:04:00.560 --> 0:04:02.840 and lend to each other, and the rates that they 0:04:02.880 --> 0:04:06.840 would lend were important to the banks. They're important to 0:04:06.880 --> 0:04:10.640 financial markets at the time. So d k B was 0:04:12.040 --> 0:04:14.680 stands for Dai Chi Kangyo Bank and we're actually the 0:04:14.800 --> 0:04:17.560 largest bank in the world at the time. And you know, 0:04:18.000 --> 0:04:22.240 I know it's my students Columbia, Japanese students and some 0:04:22.320 --> 0:04:24.120 of them, you know, have never heard of d k B. 0:04:24.240 --> 0:04:26.800 It kind of breaks my heart, you know. But then 0:04:27.480 --> 0:04:31.600 my my students at Columbia, Uh, it breaks my heart 0:04:31.640 --> 0:04:34.480 that they haven't heard of d k B because a 0:04:35.120 --> 0:04:37.479 great bank. It was a fun place to work. It's 0:04:37.560 --> 0:04:41.919 merged and formed Mizuho now, which readers will know, listeners 0:04:41.920 --> 0:04:46.039 will know. The capital markets were developing. They're developing in Japan, 0:04:47.680 --> 0:04:51.120 and it was kind of the heyday of financial engineering 0:04:51.160 --> 0:04:55.000 before the word term financial engineering became, um, you know, 0:04:55.800 --> 0:04:58.320 a way to disparage. You know, it's an exercise, and 0:04:58.320 --> 0:05:00.919 financial engineering and those as it was something to be 0:05:00.960 --> 0:05:05.159 proud of. So let's you know, let's really break this 0:05:05.240 --> 0:05:08.800 down into simple basic ideas for people like me and 0:05:08.839 --> 0:05:11.640 maybe a few of our listeners who don't know as much. 0:05:11.880 --> 0:05:16.080 You mentioned, uh, you know, the ib and library inter bank. 0:05:16.800 --> 0:05:21.719 What was it attempting to measure specifically and why did 0:05:21.960 --> 0:05:24.960 did this need there to be an index at all? Yeah, well, 0:05:24.960 --> 0:05:30.000 this was created by the British Bankers Association. It was 0:05:30.200 --> 0:05:34.760 meant to provide a benchmark index for short term borrowing costs, 0:05:34.760 --> 0:05:38.080 originally for banks, and then over time that was extended 0:05:38.120 --> 0:05:43.160 to companies, to loans, to home mortgages, and then into 0:05:43.279 --> 0:05:46.279 many different currencies as well as U S dollars. The 0:05:46.320 --> 0:05:49.560 index was created for not just three months live or 0:05:49.640 --> 0:05:53.919 but six months, one year and various other terms of 0:05:54.040 --> 0:05:56.760 one year and less. So it's set once a day 0:05:56.800 --> 0:06:01.560 in London. It's meant to reflect the term the L 0:06:01.760 --> 0:06:05.800 in Library can be confusing. It it really stands for 0:06:05.880 --> 0:06:10.240 offshore when offshore activity was headquartered in London, but it 0:06:10.279 --> 0:06:14.240 can be a deposit booked in Cayman or Nassau or 0:06:14.360 --> 0:06:18.720 London or any place that's outside of the scope of 0:06:18.720 --> 0:06:24.040 of taxation or deposit insurance to reflect the truest cost 0:06:24.120 --> 0:06:27.040 of funds that a bank would encounter without any of 0:06:27.080 --> 0:06:33.000 these special institutional details that might be UH, come with 0:06:33.040 --> 0:06:36.640 an onshore deposit. It's been a survey. It's always been 0:06:36.680 --> 0:06:38.880 a survey. And at the time the question that was 0:06:38.920 --> 0:06:42.040 created by the British Bankers Association was to pull banks 0:06:42.520 --> 0:06:44.279 and they would ask them, if you were to go 0:06:44.320 --> 0:06:50.040 out and borrow US dollars at to call another bank 0:06:50.560 --> 0:06:54.640 and in UH in normal size, what rate did you 0:06:54.760 --> 0:06:57.000 perceive you would be able to borrow if you didn't 0:06:57.040 --> 0:06:59.960 negotiate the price. So that's what makes it the off 0:07:00.000 --> 0:07:02.640 heard side. You call, you don't negotiate, and you say 0:07:02.640 --> 0:07:07.640 where where could I borrow money? M What made libror 0:07:07.839 --> 0:07:11.440 special compared to other interest rates that were in use 0:07:11.760 --> 0:07:14.280 in the eighties or the nineties. Why did the market 0:07:14.360 --> 0:07:20.000 need an expected rate versus an actual rate? You know, 0:07:20.600 --> 0:07:27.400 we had the prime rate, which was UH. Some some 0:07:27.680 --> 0:07:31.280 loans and derivatives were based off the US prime rate, 0:07:31.760 --> 0:07:35.760 which was a hard thing to understand. It was set 0:07:35.800 --> 0:07:38.920 by banks. Different banks would have different prime rates, and 0:07:39.000 --> 0:07:43.520 there wasn't much theory. There wasn't sometimes it wouldn't respond 0:07:43.600 --> 0:07:48.400 to market developments. It was and in each bank, which 0:07:48.440 --> 0:07:52.960 set it at its own discretion um there was so 0:07:53.520 --> 0:07:56.560 the market needed an index. If you wanted to borrow 0:07:56.600 --> 0:07:59.600 money and you wanted the rate to go up. You 0:07:59.680 --> 0:08:02.240 could except the rate going up if inflation went up 0:08:02.720 --> 0:08:05.440 or short term rates go up according to the business cycle. 0:08:05.840 --> 0:08:08.720 This was the index. Another know, another possibility would be 0:08:08.760 --> 0:08:12.520 to use US Treasury bills, but those have their own 0:08:12.520 --> 0:08:15.800 special features that might not be relevant to a company 0:08:15.840 --> 0:08:18.720 that was borrowing or a bank that was borrowing. The 0:08:18.800 --> 0:08:21.240 rate on US Treasury bills could depend on the supply 0:08:21.280 --> 0:08:26.120 and demand of T bills. It could depend on yeah 0:08:26.960 --> 0:08:29.520 costs of borrowing in the private credit markets could go 0:08:29.600 --> 0:08:33.600 up without a corresponding change in Treasury bills, and banks 0:08:33.600 --> 0:08:36.520 would Banks that were receiving live ard payments would expect 0:08:36.559 --> 0:08:40.199 to see more and UH that would not be accounted 0:08:40.240 --> 0:08:42.480 for in an index based on treasury bill So there 0:08:42.520 --> 0:08:47.520 was a demand for an index. It had to be 0:08:47.559 --> 0:08:51.679 based on a survey. They would survey. The survey got 0:08:51.720 --> 0:08:56.080 up to twenty banks. Banks voluntarily participated at the time 0:08:56.120 --> 0:08:58.840 because it was considered prestigious to be in the index, 0:08:59.600 --> 0:09:04.000 and they British Bankers Association would throw out the you know, 0:09:04.360 --> 0:09:08.000 when it got up to when it was sixteen banks, 0:09:08.000 --> 0:09:10.520 they would throw out the top four and the bottom four. 0:09:10.840 --> 0:09:13.560 They were pulled each morning at eleven o'clock London time, 0:09:13.960 --> 0:09:16.439 throughout the top four, the bottom four average, the eight 0:09:16.520 --> 0:09:20.720 that remained round to five decimal places and that's US 0:09:20.800 --> 0:09:24.199 dollar libar that day in one month, two month, three months, 0:09:25.040 --> 0:09:27.240 four or five, six, and so on up to twelve months. 0:09:28.440 --> 0:09:32.400 So it's kind of like how they measure gymnastics or 0:09:32.480 --> 0:09:35.280 ice skating at the Olympics and they throw out the 0:09:35.360 --> 0:09:38.240 Russian judge and they throw out the US judge so 0:09:38.400 --> 0:09:42.040 that they skew unscrew the polls, and then everyone else 0:09:42.080 --> 0:09:44.840 they get an average. Yeah, and it's also similar and 0:09:44.840 --> 0:09:46.640 that you get to see what in the Olympics. You 0:09:46.679 --> 0:09:51.280 see what each judge rates the performance. Uh. It was 0:09:51.320 --> 0:09:53.520 also out in the open at the time, so you 0:09:53.520 --> 0:09:57.000 could see what right each bank that was in the survey, 0:09:57.080 --> 0:09:59.920 which rate, what rate they posted. We tend to think 0:10:00.000 --> 0:10:03.319 of transparency is being virtuous and good under every circumstance, 0:10:03.360 --> 0:10:06.600 but that was part of that was also a part 0:10:06.640 --> 0:10:09.200 of the problem at the time, because if a bank 0:10:09.320 --> 0:10:12.520 was perceiving that was having funding troubles, it would have 0:10:12.559 --> 0:10:14.960 a self interest not to reveal that to the whole 0:10:14.960 --> 0:10:18.680 world by posting a high rate. There's the question posed 0:10:18.760 --> 0:10:21.720 by the British Bankers Association, if you went to borrow 0:10:22.200 --> 0:10:26.160 without negotiating, what rate do you perceive? And let's say 0:10:26.360 --> 0:10:31.199 in the late nineties during the Asian crisis, a bank 0:10:31.280 --> 0:10:35.240 like d k B or Fujibank was having funding pressures. 0:10:35.280 --> 0:10:37.360 They didn't want to say, oh, well, all right, would 0:10:37.360 --> 0:10:39.520 be very high because nobody wants to lend to us, 0:10:39.559 --> 0:10:41.240 and by the way, we just want everybody to see 0:10:41.280 --> 0:11:01.160 it in this official calculation. So there was a moment 0:11:01.640 --> 0:11:04.720 in um again. I think it was the late nineties 0:11:05.000 --> 0:11:10.200 when library sort of became even more embedded with the 0:11:10.240 --> 0:11:13.520 financial market, and that was when the CME, the Chicago 0:11:13.640 --> 0:11:18.000 Mercantile Exchange decided to use libor instead of a reference 0:11:18.120 --> 0:11:22.360 rate that it had been calculating previously. Why did it 0:11:22.440 --> 0:11:26.319 decide to do that and how did that impact the 0:11:26.360 --> 0:11:32.320 market and librars overall integration with the market. The Chicago 0:11:32.360 --> 0:11:37.120 Mercantile Exchange had a contract UH that it launched shortly 0:11:37.160 --> 0:11:43.000 after the British Bankers Association created libor. The They used 0:11:43.000 --> 0:11:44.760 to have also another index they used to have as 0:11:44.760 --> 0:11:47.320 a commercial paper index, but that also had a lot 0:11:47.360 --> 0:11:50.480 of idiosyncrasies that were attached to it. That made it, 0:11:51.200 --> 0:11:54.040 that made it unhelpful. So they switched to something that 0:11:54.040 --> 0:11:58.040 they call your dollars and euro dollars were based on 0:11:58.200 --> 0:12:01.280 an index that the Chicago More can Till Exchange created 0:12:01.760 --> 0:12:05.560 to try to mimic the mimic library, and it would 0:12:05.600 --> 0:12:08.439 differ from library by a basis point or two. So 0:12:08.920 --> 0:12:13.240 there they would conduct their survey on four times a 0:12:13.320 --> 0:12:18.600 year on the Monday before the third Wednesday of every March, June, September, 0:12:18.600 --> 0:12:21.839 and December. So and it was they would draw from 0:12:21.840 --> 0:12:25.240 a very large panel of banks. It was random. Then 0:12:25.400 --> 0:12:29.320 they would they picked twenty banks, and then they threw 0:12:29.320 --> 0:12:32.000 out the top and the bottom it was anonymous, and 0:12:32.000 --> 0:12:34.560 then they did the whole thing again. They randomized again 0:12:34.600 --> 0:12:37.320 to pick twenty banks, and then they surveyed them. They 0:12:37.320 --> 0:12:39.760 didn't know banks, didn't know who was going to be surveyed, 0:12:39.920 --> 0:12:42.440 and then they would average the results of those of 0:12:42.440 --> 0:12:46.680 those two surveys together. Um it was. It was created 0:12:47.160 --> 0:12:49.079 and in the in the mid eighties by the chief 0:12:49.080 --> 0:12:52.040 economist fred Ar Ditty at the Chicago Mark Until Exchange, 0:12:52.040 --> 0:12:56.319 who who was a beloved character in the futures markets 0:12:57.240 --> 0:13:03.720 by many people, including me, UM and then in ninety 0:13:04.120 --> 0:13:08.920 sex the Chicago more Until Exchange applied to the CFTC 0:13:09.520 --> 0:13:14.280 to switch to using the Official British Bankers Association UH contract. 0:13:14.720 --> 0:13:17.559 They were worried at the time that some competitive competitive 0:13:17.559 --> 0:13:23.280 exchange would create a contract based on Official Library and 0:13:23.320 --> 0:13:26.520 that that might give them an advantage because loans, interest 0:13:26.600 --> 0:13:29.920 rate swaps and so forth we're all tied to the 0:13:29.960 --> 0:13:33.320 Official Library. Talks to us a little bit about that 0:13:33.360 --> 0:13:38.240 sort of network effect. Why in why there are can't 0:13:38.240 --> 0:13:41.120 be or why it's difficult to imagine a world of 0:13:41.480 --> 0:13:45.719 multiple indexes or mortgages and credit cards and all these 0:13:45.760 --> 0:13:50.280 things and they all eventually sort of uh coalesce around one. 0:13:50.520 --> 0:13:54.280 Why does that naturally happen? And uh one sort of 0:13:54.320 --> 0:13:57.560 has to emerge the LIB you know, if there are 0:13:57.559 --> 0:14:01.640 many industries around first to create its noise. For if 0:14:01.679 --> 0:14:03.560 you if you have an interest rate swap and you're 0:14:03.600 --> 0:14:08.160 paying b B a official library, and you're hedging using 0:14:08.200 --> 0:14:11.240 your dollar futures, you have a kind of basis risk there. 0:14:11.360 --> 0:14:13.720 Now you can be trying to be very clever and 0:14:13.840 --> 0:14:17.040 understand the basis risk and make it operate to your advantage. 0:14:17.280 --> 0:14:21.240 People try to do that and then if there are 0:14:21.240 --> 0:14:24.200 many industries floating around, the users of those industries will 0:14:24.360 --> 0:14:28.520 worry that, you know, some whoever is offering them the 0:14:28.520 --> 0:14:31.640 product or some index that they didn't expect, is doing 0:14:31.680 --> 0:14:35.560 this in an unscrupulous way. So if there's a single index, 0:14:35.760 --> 0:14:38.720 then it's the same for everybody. And it's clearly the 0:14:38.760 --> 0:14:41.720 same for everybody. I think it's a healthy thing, just 0:14:41.840 --> 0:14:44.360 not the index of the b B A head. So 0:14:44.560 --> 0:14:48.720 by library has sort of edged out a bunch of 0:14:48.720 --> 0:14:51.440 other rates in the market and sort of is on 0:14:51.440 --> 0:14:54.320 its way to becoming the standard. The CME has just 0:14:54.360 --> 0:14:58.520 adopted it for Euro dollar futures, and that I think 0:14:58.760 --> 0:15:02.160 is when you wrote your very well known letter to 0:15:02.240 --> 0:15:06.240 the CFTC in protest of this move. What did the 0:15:06.320 --> 0:15:09.640 letters say? Yeah, I wrote the letter before they actually 0:15:09.960 --> 0:15:12.960 had permission from the CFTC to make the switch because 0:15:12.960 --> 0:15:15.040 I wanted to stop them from doing it, because I 0:15:15.040 --> 0:15:17.920 thought their survey was much better than the than the 0:15:17.960 --> 0:15:22.680 B B A survey. I argued that there were two 0:15:22.720 --> 0:15:26.480 problems with the b B A index. First, that a 0:15:26.560 --> 0:15:30.120 small number of banks were were selected and the same 0:15:30.120 --> 0:15:32.880 ones were selected again and again. They were all active 0:15:32.880 --> 0:15:36.320 participants in derivatives and that they might move the rate 0:15:36.600 --> 0:15:39.520 to their own advantage, that they might manipulate it. At 0:15:39.520 --> 0:15:45.360 the time, it was unregulated, there were no particular criminal 0:15:45.400 --> 0:15:48.920 penalties for doing this, and all that's changed after after 0:15:48.960 --> 0:15:52.720 the crisis. Um. And then I also argued that a 0:15:52.760 --> 0:15:58.560 bank might try to disguise its funding troubles because it 0:15:58.640 --> 0:16:02.080 was because it didn't want to make them worse by 0:16:02.240 --> 0:16:04.640 posting a high rate. If that's what it truly believed 0:16:05.080 --> 0:16:06.800 in the letter, I just I just dug up the 0:16:06.880 --> 0:16:11.440 letter the other day before I came to see you, 0:16:11.920 --> 0:16:15.360 and I wrote in the letter that you know the 0:16:15.360 --> 0:16:18.160 CME claims that the b b A survey will self 0:16:18.200 --> 0:16:21.320 correct if markets become more volatile. They argue that the 0:16:21.320 --> 0:16:24.360 outstanding notional of instruments tied to b b A fixings 0:16:24.440 --> 0:16:28.640 is enormous, and I wrote, but enormous markets create enormous temptations. 0:16:28.960 --> 0:16:31.360 The CME argument works only to the extent that we 0:16:31.440 --> 0:16:34.960 rely on BBA members to look beyond their self interests. Again, 0:16:35.000 --> 0:16:38.680 without impugning any of the b b A banks, we 0:16:38.760 --> 0:16:40.840 do not consider this to be a sound basis for 0:16:40.880 --> 0:16:44.320 predicting human behavior. So I was a snarky little guy then, 0:16:44.480 --> 0:16:49.240 But well, obviously spot on two. But so in retrospect, 0:16:49.760 --> 0:16:54.160 obviously your argument, we'll get to the manipulation that did occur, 0:16:54.280 --> 0:16:57.400 But in retrospect the issues that you highlighted back then, 0:16:57.480 --> 0:17:00.640 they're like, oh, yeah, it seems obvious the potential for 0:17:00.720 --> 0:17:03.600 manipulation to make trades go one way, and a bank 0:17:03.640 --> 0:17:07.120 facing funding stress isn't going to want to put an 0:17:07.119 --> 0:17:10.679 accurate number on a survey in which the survey is 0:17:11.000 --> 0:17:14.480 not anonymous, So that all seems like obvious in retrospect. 0:17:14.880 --> 0:17:18.160 Why wasn't this a source of concern from the very 0:17:18.160 --> 0:17:21.800 beginning or while? Because? Yeah, why weren't there more worried 0:17:21.800 --> 0:17:26.199 about that? Because it seemed to be working? Uh, it was. 0:17:26.760 --> 0:17:30.720 The derivatives market was growing, that forward rate agreements, which 0:17:30.760 --> 0:17:34.080 are tied to live or were growing. Um, the whole 0:17:34.119 --> 0:17:38.160 market was centered on live ar was expanding to sixteen currencies. 0:17:38.640 --> 0:17:42.640 It's I think you have to wait for something bad 0:17:42.720 --> 0:17:45.399 to happen before you can disrupt a force like that 0:17:45.440 --> 0:17:48.520 sounds like how the world works, and I'm afraid it does. Yeah. 0:17:48.640 --> 0:17:51.359 Did anyone from the c f TC get back to you? Yeah, 0:17:52.280 --> 0:17:55.880 they got back to me. As I recall, they said 0:17:55.920 --> 0:17:58.720 they worked at a daylet it was a business decision, 0:17:59.040 --> 0:18:03.359 and they gave me a sweatshirt. They gave you a sweatshirt. 0:18:04.080 --> 0:18:08.480 Do you still have it? Oh? Man? That that that 0:18:08.560 --> 0:18:14.679 was That was the outcome. Ah, I love that detail. Um. 0:18:14.840 --> 0:18:19.600 So obviously librar continued to grow by the time, you know, 0:18:19.760 --> 0:18:22.080 fast forward a few years, by the time we get 0:18:22.160 --> 0:18:26.320 to the financial crisis and when the Shenanigan started to 0:18:26.320 --> 0:18:30.399 be uncovered. How much of the world credit markets and 0:18:30.440 --> 0:18:34.040 how much was linked then to this one index. You know, 0:18:34.200 --> 0:18:37.080 they say that US dollar libar has a four dred 0:18:37.119 --> 0:18:40.960 and fifty trillion dollar footprint right now. It's probably about 0:18:41.000 --> 0:18:42.600 the same at the time if you count your at 0:18:42.600 --> 0:18:47.360 dollar futures, corporate loans, all loans are tied to live bar. 0:18:48.440 --> 0:18:50.879 This is just dollars and it's probably just as big 0:18:51.000 --> 0:18:56.639 in euros tied to your eye bar um, British poems, yeah, 0:18:57.040 --> 0:19:00.080 Swiss frank and many other currencies at the time. So 0:19:00.160 --> 0:19:04.280 the number safe something. I mean, if you count every 0:19:04.320 --> 0:19:06.720 year at all our futures contract you get to quite 0:19:06.880 --> 0:19:10.000 lofty numbers. I mean adding them all together is is 0:19:11.160 --> 0:19:14.480 in a way kind of buff fishy. But that's that 0:19:15.280 --> 0:19:18.240 it's huge by by any standards of hugeness, it's huge. 0:19:19.520 --> 0:19:22.919 So if we fast forward to two thousand eight or 0:19:22.960 --> 0:19:27.080 two thousand nine, as far as I can remember, the 0:19:27.200 --> 0:19:31.000 charges of liborary manipulation or the rumors of liborary manipulation 0:19:31.440 --> 0:19:35.760 started surfacing in the financial media I think in early 0:19:35.800 --> 0:19:38.240 two thousand nine, and you sort of got a steady 0:19:38.320 --> 0:19:43.880 drip of allegations of certain behavior. What did you think 0:19:44.400 --> 0:19:46.720 in those days watching this where you just sort of 0:19:46.760 --> 0:19:52.200 sat in your office, going, see, I told you so hopefully. Uh, 0:19:52.440 --> 0:19:56.280 in those days I had other things, um problems of 0:19:56.320 --> 0:19:59.359 my own at that moment. There's a key turning point 0:19:59.640 --> 0:20:01.879 in the first quarter of two thousand and eight in 0:20:02.040 --> 0:20:05.800 understanding what happened to Liebor, we have to recognize the 0:20:05.880 --> 0:20:08.960 change in the policy of the Federal Reserve to start 0:20:09.000 --> 0:20:12.640 paying interest on access reserves that banks held at the FED. 0:20:13.800 --> 0:20:17.960 Banks would the starting in in Q one O eight um. 0:20:18.000 --> 0:20:21.000 The Fed would pay at the top of its target 0:20:20.880 --> 0:20:23.280 at at its target rate, and then later at the 0:20:23.280 --> 0:20:26.320 top of its target range money that banks left at 0:20:26.359 --> 0:20:30.560 the fat So why would I lend to another bank 0:20:30.680 --> 0:20:32.640 when I could just leave the money at the Central 0:20:32.640 --> 0:20:36.280 Bank and get a generous interest rate, I wouldn't. So 0:20:36.359 --> 0:20:40.440 as a result of that, library became unhinged to anything 0:20:40.440 --> 0:20:43.160 that was happening in the world. Two thousand seven. It's 0:20:43.200 --> 0:20:45.280 not not to do with the financial crisis. Is just 0:20:45.560 --> 0:20:47.920 a change that Bernanke had planned for a long time 0:20:47.920 --> 0:20:52.439 at the Federal Reserve. So the interbank, the ib and 0:20:52.480 --> 0:20:58.800 the liebar vanished. So it left banks to really guess 0:20:59.160 --> 0:21:01.919 what they might borrow if they were to borrow, even 0:21:01.960 --> 0:21:05.000 though they hadn't borrowed no long time. There's a year's 0:21:05.119 --> 0:21:10.080 roll by. It became, you know, the individuals at the 0:21:10.080 --> 0:21:16.920 banks responsible for submitting the uh libar each day would 0:21:16.920 --> 0:21:19.320 just uh, you know, imagine what they might have done 0:21:19.320 --> 0:21:22.320 if an interbank market still existed, but it didn't exist. 0:21:23.160 --> 0:21:26.320 Talk to us a little bit more about the process 0:21:26.400 --> 0:21:29.359 back when it had existed and then didn't. So the 0:21:29.400 --> 0:21:31.960 survey says, what do you think that you could borrow 0:21:32.000 --> 0:21:35.080 at if you weren't negotiating? What would you be offered at? 0:21:35.560 --> 0:21:39.399 What was the actual process within a generic bank, someone's 0:21:39.480 --> 0:21:41.280 job was to come up with that number. How would 0:21:41.280 --> 0:21:43.280 they have done that? And then how did that change 0:21:43.400 --> 0:21:45.919 once that market disappeared. I can only speak from my 0:21:46.000 --> 0:21:48.200 own bank at the time. We would wait. There was 0:21:48.240 --> 0:21:50.840 a bank called Fujibank that would submit it, and you 0:21:50.840 --> 0:21:52.919 could see their submission, and we would wait and do 0:21:53.040 --> 0:21:56.240 something close to their What they actually did at Fujibank, 0:21:56.720 --> 0:22:01.920 I don't know, but it would. It would pretty much 0:22:01.960 --> 0:22:06.520 be based on at the time on what the overnight 0:22:06.600 --> 0:22:11.080 rate was, plus an expectation for what the overnight rate 0:22:11.080 --> 0:22:15.800 would average over the term because borrowing overnight overnight rolling 0:22:15.840 --> 0:22:19.679 it for ninety days is a substitute for borrowing for 0:22:19.800 --> 0:22:23.720 ninety days at a term rate. So more or less 0:22:24.040 --> 0:22:27.560 be the bank's estimate of what they expected from the 0:22:27.600 --> 0:22:31.240 Federal Reserve over the three month period, and then a 0:22:31.240 --> 0:22:34.879 little bit more because it was the offered side the 0:22:34.960 --> 0:22:39.680 o r. And then if there were some liquidity premium, 0:22:39.760 --> 0:22:45.320 some pressures on term funding, some extra compensation that a 0:22:45.359 --> 0:22:47.560 bank would be willing to pay for having the money 0:22:47.600 --> 0:22:50.800 for three months or six months, then they would tack 0:22:50.840 --> 0:22:53.000 on a basis point or two for that. But it 0:22:53.080 --> 0:22:55.800 was that was actually very small. So it's really just 0:22:56.040 --> 0:22:58.240 what do we think the overnight rate will average during 0:22:58.240 --> 0:23:01.840 this time, um us a little bit for the offered side, 0:23:02.040 --> 0:23:04.920 and that that was how it worked. Could you walk 0:23:05.000 --> 0:23:10.000 us through the exact motivations for manipulating library because and 0:23:10.160 --> 0:23:14.240 and specifically the motivation for manipulating librar higher because I 0:23:14.280 --> 0:23:17.600 think a lot of people will understand that. You know, 0:23:18.119 --> 0:23:20.680 you might low ball the number because you don't want 0:23:20.720 --> 0:23:24.560 to out yourself as having a higher rate of borrowing 0:23:24.600 --> 0:23:26.879 in the inter bank market than some of your other 0:23:27.240 --> 0:23:30.520 bank peers. But why would anyone want to manipulate the 0:23:30.640 --> 0:23:33.680 rate higher? How did that work? Okay? There are two 0:23:33.720 --> 0:23:37.639 classes of manipulation here. The first is if you're receiving 0:23:37.760 --> 0:23:41.440 or making a payment tied to libor, you might if 0:23:41.440 --> 0:23:44.199 you're making a payment, you would like it a little lower. 0:23:44.520 --> 0:23:47.440 If you're receiving a payment tied to live or, you 0:23:47.480 --> 0:23:49.800 would like it to be a little higher. Now, you 0:23:49.880 --> 0:23:53.040 might be making a payment or receiving a payment depending 0:23:53.760 --> 0:23:56.720 most likely tied to an interest rate swap. So in 0:23:56.800 --> 0:23:59.439 an interest rate swap, a bank will pay fixed and 0:23:59.480 --> 0:24:04.320 receive a sequence of payments based on live or or. 0:24:04.359 --> 0:24:07.880 If it's um receiving a fixed rate, it will make 0:24:07.880 --> 0:24:11.480 payments tied to live or. So it's completely symmetrical that way. 0:24:11.520 --> 0:24:13.960 There may be days when a bank has a big 0:24:14.320 --> 0:24:17.200 live or fixing on an interest rate swap where it's 0:24:17.200 --> 0:24:19.719 receiving fixed and would like it to be a little higher, 0:24:19.840 --> 0:24:21.760 or days when it's paying fixed and would like it 0:24:21.800 --> 0:24:24.639 to be a little lower. That's that's kind of a 0:24:24.680 --> 0:24:29.720 micro manipulation. And then there's the other there's there's the 0:24:29.800 --> 0:24:34.000 signaling effect where it would like to create lower It 0:24:34.080 --> 0:24:36.320 doesn't want to stand out from the crowd if there's 0:24:36.400 --> 0:24:41.720 suspicion that it has um funding problems. The so called 0:24:41.880 --> 0:24:45.240 Live War scandal was the first kind of manipulation where 0:24:45.240 --> 0:24:51.040 banks would presumably change their rate based on what was 0:24:51.080 --> 0:25:09.800 going to happen on their self interest at that day. Now, 0:25:10.000 --> 0:25:12.760