Speaker 1: Hello, and welcome to another episode of the Odd Thoughts podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. Wisn't all so, Joe.
Speaker 1: We're finally doing it. We're finally doing our live ard series.
Speaker 1: Uh yeah, we've been talking about this for a while,
Speaker 1: the idea of doing a big series on librar, what
Speaker 1: happened to it, what it was, what his state is now,
Speaker 1: where it's going, and uh, we're going to kick it off. Yep.
Speaker 1: This is the first of those episodes. So just as
Speaker 1: an introduction, let's talk about what libor is. Librar is
Speaker 1: the London Interbank Offered rate, and it is, as you mentioned, Joe,
Speaker 1: in a state of transition. Just for background, this is
Speaker 1: basically the reference rate that governs trillions of dollars worth
Speaker 1: of asset prices. So, for instance, if you sell a
Speaker 1: bond in the market, it will be priced off lib
Speaker 1: or um, so whatever the inter bank offered rate is
Speaker 1: plus an additional yield. Same thing if you sell alone
Speaker 1: home mortgages priced off lib or. Basically, the financial system
Speaker 1: has for many many years run on library and that
Speaker 1: is a big deal because we are supposed to be
Speaker 1: moving away from that particular reference rate, right, So this
Speaker 1: is not a topic that I know particularly well. I
Speaker 1: know about the centrality of the rate. I know that
Speaker 1: there is an effort afoot to move all of these
Speaker 1: various offerings that currently index in some way to libel
Speaker 1: onto something new, which will get to in this series.
Speaker 1: And I know that around the time of the crisis
Speaker 1: there was a manipulation of this price and that that
Speaker 1: was a major scandal, and that the way the price
Speaker 1: is set and measured opened itself to all kinds of shenanigans.
Speaker 1: But honestly, I don't know much more about it than that.
Speaker 1: I don't know much about its history. I don't know
Speaker 1: the degree to which the manipulation really affected things. I
Speaker 1: don't know why it's so difficult to change, and I'm
Speaker 1: very much looking forward to learning more as we embark
Speaker 1: on this series, because although I don't know very much
Speaker 1: about it, I get the sense that this is extremely
Speaker 1: important and that people in credit market it's one of
Speaker 1: the big things that is going to affect their industry,
Speaker 1: and that they're all watching absolutely And you've set the
Speaker 1: scene perfectly, and we are actually going to start with
Speaker 1: a discussion about what lib or is, how it came
Speaker 1: into being and of course the manipulation scandal that happened
Speaker 1: after the financial crisis. So it's a good place to start.
Speaker 1: And our guest is actually the perfect guests to talk
Speaker 1: about this. Uh. He's basically been a Cassandra when it
Speaker 1: comes to warning about the potential for banks to do
Speaker 1: sketchy stuff with lib or. His name is Richard Rob.
Speaker 1: He's currently the CEO of the hedge fund Christoffers and
Speaker 1: Rob also a professor at Columbia and many many years ago,
Speaker 1: he was actually a rates trader at d KB Financial
Speaker 1: in New York, and he famously wrote a letter to
Speaker 1: one of the regulators, the CFDC, warning of the potential
Speaker 1: for library manipulation. And this was way back in I
Speaker 1: think the late So really the perfect person to discuss this.
Speaker 1: I can't wait. I can't wait to learn all about it. Excellent, Richard,
Speaker 1: thank you so much for coming on. Great to be here,
Speaker 1: so I guess too. Just to begin with, I'm curious,
Speaker 1: what was it like being a rates trader in the nineties.
Speaker 1: Quite a lot happening back then when it comes to
Speaker 1: interest rates. Oh, it was so much fun. Um the
Speaker 1: interest rates would move ten fifteen bases points. Today the
Speaker 1: interbank market was very active. You know, the ib and
Speaker 1: lib or stands for interbank. So banks would and borrow
Speaker 1: and lend to each other, and the rates that they
Speaker 1: would lend were important to the banks. They're important to
Speaker 1: financial markets at the time. So d k B was
Speaker 1: stands for Dai Chi Kangyo Bank and we're actually the
Speaker 1: largest bank in the world at the time. And you know,
Speaker 1: I know it's my students Columbia, Japanese students and some
Speaker 1: of them, you know, have never heard of d k B.
Speaker 1: It kind of breaks my heart, you know. But then
Speaker 1: my my students at Columbia, Uh, it breaks my heart
Speaker 1: that they haven't heard of d k B because a
Speaker 1: great bank. It was a fun place to work. It's
Speaker 1: merged and formed Mizuho now, which readers will know, listeners
Speaker 1: will know. The capital markets were developing. They're developing in Japan,
Speaker 1: and it was kind of the heyday of financial engineering
Speaker 1: before the word term financial engineering became, um, you know,
Speaker 1: a way to disparage. You know, it's an exercise, and
Speaker 1: financial engineering and those as it was something to be
Speaker 1: proud of. So let's you know, let's really break this
Speaker 1: down into simple basic ideas for people like me and
Speaker 1: maybe a few of our listeners who don't know as much.
Speaker 1: You mentioned, uh, you know, the ib and library inter bank.
Speaker 1: What was it attempting to measure specifically and why did
Speaker 1: did this need there to be an index at all? Yeah, well,
Speaker 1: this was created by the British Bankers Association. It was
Speaker 1: meant to provide a benchmark index for short term borrowing costs,
Speaker 1: originally for banks, and then over time that was extended
Speaker 1: to companies, to loans, to home mortgages, and then into
Speaker 1: many different currencies as well as U S dollars. The
Speaker 1: index was created for not just three months live or
Speaker 1: but six months, one year and various other terms of
Speaker 1: one year and less. So it's set once a day
Speaker 1: in London. It's meant to reflect the term the L
Speaker 1: in Library can be confusing. It it really stands for
Speaker 1: offshore when offshore activity was headquartered in London, but it
Speaker 1: can be a deposit booked in Cayman or Nassau or
Speaker 1: London or any place that's outside of the scope of
Speaker 1: of taxation or deposit insurance to reflect the truest cost
Speaker 1: of funds that a bank would encounter without any of
Speaker 1: these special institutional details that might be UH, come with
Speaker 1: an onshore deposit. It's been a survey. It's always been
Speaker 1: a survey. And at the time the question that was
Speaker 1: created by the British Bankers Association was to pull banks
Speaker 1: and they would ask them, if you were to go
Speaker 1: out and borrow US dollars at to call another bank
Speaker 1: and in UH in normal size, what rate did you
Speaker 1: perceive you would be able to borrow if you didn't
Speaker 1: negotiate the price. So that's what makes it the off
Speaker 1: heard side. You call, you don't negotiate, and you say
Speaker 1: where where could I borrow money? M What made libror
Speaker 1: special compared to other interest rates that were in use
Speaker 1: in the eighties or the nineties. Why did the market
Speaker 1: need an expected rate versus an actual rate? You know,
Speaker 1: we had the prime rate, which was UH. Some some
Speaker 1: loans and derivatives were based off the US prime rate,
Speaker 1: which was a hard thing to understand. It was set
Speaker 1: by banks. Different banks would have different prime rates, and
Speaker 1: there wasn't much theory. There wasn't sometimes it wouldn't respond
Speaker 1: to market developments. It was and in each bank, which
Speaker 1: set it at its own discretion um there was so
Speaker 1: the market needed an index. If you wanted to borrow
Speaker 1: money and you wanted the rate to go up. You
Speaker 1: could except the rate going up if inflation went up
Speaker 1: or short term rates go up according to the business cycle.
Speaker 1: This was the index. Another know, another possibility would be
Speaker 1: to use US Treasury bills, but those have their own
Speaker 1: special features that might not be relevant to a company
Speaker 1: that was borrowing or a bank that was borrowing. The
Speaker 1: rate on US Treasury bills could depend on the supply
Speaker 1: and demand of T bills. It could depend on yeah
Speaker 1: costs of borrowing in the private credit markets could go
Speaker 1: up without a corresponding change in Treasury bills, and banks
Speaker 1: would Banks that were receiving live ard payments would expect
Speaker 1: to see more and UH that would not be accounted
Speaker 1: for in an index based on treasury bill So there
Speaker 1: was a demand for an index. It had to be
Speaker 1: based on a survey. They would survey. The survey got
Speaker 1: up to twenty banks. Banks voluntarily participated at the time
Speaker 1: because it was considered prestigious to be in the index,
Speaker 1: and they British Bankers Association would throw out the you know,
Speaker 1: when it got up to when it was sixteen banks,
Speaker 1: they would throw out the top four and the bottom four.
Speaker 1: They were pulled each morning at eleven o'clock London time,
Speaker 1: throughout the top four, the bottom four average, the eight
Speaker 1: that remained round to five decimal places and that's US
Speaker 1: dollar libar that day in one month, two month, three months,
Speaker 1: four or five, six, and so on up to twelve months.
Speaker 1: So it's kind of like how they measure gymnastics or
Speaker 1: ice skating at the Olympics and they throw out the
Speaker 1: Russian judge and they throw out the US judge so
Speaker 1: that they skew unscrew the polls, and then everyone else
Speaker 1: they get an average. Yeah, and it's also similar and
Speaker 1: that you get to see what in the Olympics. You
Speaker 1: see what each judge rates the performance. Uh. It was
Speaker 1: also out in the open at the time, so you
Speaker 1: could see what right each bank that was in the survey,
Speaker 1: which rate, what rate they posted. We tend to think
Speaker 1: of transparency is being virtuous and good under every circumstance,
Speaker 1: but that was part of that was also a part
Speaker 1: of the problem at the time, because if a bank
Speaker 1: was perceiving that was having funding troubles, it would have
Speaker 1: a self interest not to reveal that to the whole
Speaker 1: world by posting a high rate. There's the question posed
Speaker 1: by the British Bankers Association, if you went to borrow
Speaker 1: without negotiating, what rate do you perceive? And let's say
Speaker 1: in the late nineties during the Asian crisis, a bank
Speaker 1: like d k B or Fujibank was having funding pressures.
Speaker 1: They didn't want to say, oh, well, all right, would
Speaker 1: be very high because nobody wants to lend to us,
Speaker 1: and by the way, we just want everybody to see
Speaker 1: it in this official calculation. So there was a moment
Speaker 1: in um again. I think it was the late nineties
Speaker 1: when library sort of became even more embedded with the
Speaker 1: financial market, and that was when the CME, the Chicago
Speaker 1: Mercantile Exchange decided to use libor instead of a reference
Speaker 1: rate that it had been calculating previously. Why did it
Speaker 1: decide to do that and how did that impact the
Speaker 1: market and librars overall integration with the market. The Chicago
Speaker 1: Mercantile Exchange had a contract UH that it launched shortly
Speaker 1: after the British Bankers Association created libor. The They used
Speaker 1: to have also another index they used to have as
Speaker 1: a commercial paper index, but that also had a lot
Speaker 1: of idiosyncrasies that were attached to it. That made it,
Speaker 1: that made it unhelpful. So they switched to something that
Speaker 1: they call your dollars and euro dollars were based on
Speaker 1: an index that the Chicago More can Till Exchange created
Speaker 1: to try to mimic the mimic library, and it would
Speaker 1: differ from library by a basis point or two. So
Speaker 1: there they would conduct their survey on four times a
Speaker 1: year on the Monday before the third Wednesday of every March, June, September,
Speaker 1: and December. So and it was they would draw from
Speaker 1: a very large panel of banks. It was random. Then
Speaker 1: they would they picked twenty banks, and then they threw
Speaker 1: out the top and the bottom it was anonymous, and
Speaker 1: then they did the whole thing again. They randomized again
Speaker 1: to pick twenty banks, and then they surveyed them. They
Speaker 1: didn't know banks, didn't know who was going to be surveyed,
Speaker 1: and then they would average the results of those of
Speaker 1: those two surveys together. Um it was. It was created
Speaker 1: and in the in the mid eighties by the chief
Speaker 1: economist fred Ar Ditty at the Chicago Mark Until Exchange,
Speaker 1: who who was a beloved character in the futures markets
Speaker 1: by many people, including me, UM and then in ninety
Speaker 1: sex the Chicago more Until Exchange applied to the CFTC
Speaker 1: to switch to using the Official British Bankers Association UH contract.
Speaker 1: They were worried at the time that some competitive competitive
Speaker 1: exchange would create a contract based on Official Library and
Speaker 1: that that might give them an advantage because loans, interest
Speaker 1: rate swaps and so forth we're all tied to the
Speaker 1: Official Library. Talks to us a little bit about that
Speaker 1: sort of network effect. Why in why there are can't
Speaker 1: be or why it's difficult to imagine a world of
Speaker 1: multiple indexes or mortgages and credit cards and all these
Speaker 1: things and they all eventually sort of uh coalesce around one.
Speaker 1: Why does that naturally happen? And uh one sort of
Speaker 1: has to emerge the LIB you know, if there are
Speaker 1: many industries around first to create its noise. For if
Speaker 1: you if you have an interest rate swap and you're
Speaker 1: paying b B a official library, and you're hedging using
Speaker 1: your dollar futures, you have a kind of basis risk there.
Speaker 1: Now you can be trying to be very clever and
Speaker 1: understand the basis risk and make it operate to your advantage.
Speaker 1: People try to do that and then if there are
Speaker 1: many industries floating around, the users of those industries will
Speaker 1: worry that, you know, some whoever is offering them the
Speaker 1: product or some index that they didn't expect, is doing
Speaker 1: this in an unscrupulous way. So if there's a single index,
Speaker 1: then it's the same for everybody. And it's clearly the
Speaker 1: same for everybody. I think it's a healthy thing, just
Speaker 1: not the index of the b B A head. So
Speaker 1: by library has sort of edged out a bunch of
Speaker 1: other rates in the market and sort of is on
Speaker 1: its way to becoming the standard. The CME has just
Speaker 1: adopted it for Euro dollar futures, and that I think
Speaker 1: is when you wrote your very well known letter to
Speaker 1: the CFTC in protest of this move. What did the
Speaker 1: letters say? Yeah, I wrote the letter before they actually
Speaker 1: had permission from the CFTC to make the switch because
Speaker 1: I wanted to stop them from doing it, because I
Speaker 1: thought their survey was much better than the than the
Speaker 1: B B A survey. I argued that there were two
Speaker 1: problems with the b B A index. First, that a
Speaker 1: small number of banks were were selected and the same
Speaker 1: ones were selected again and again. They were all active
Speaker 1: participants in derivatives and that they might move the rate
Speaker 1: to their own advantage, that they might manipulate it. At
Speaker 1: the time, it was unregulated, there were no particular criminal
Speaker 1: penalties for doing this, and all that's changed after after
Speaker 1: the crisis. Um. And then I also argued that a
Speaker 1: bank might try to disguise its funding troubles because it
Speaker 1: was because it didn't want to make them worse by
Speaker 1: posting a high rate. If that's what it truly believed
Speaker 1: in the letter, I just I just dug up the
Speaker 1: letter the other day before I came to see you,
Speaker 1: and I wrote in the letter that you know the
Speaker 1: CME claims that the b b A survey will self
Speaker 1: correct if markets become more volatile. They argue that the
Speaker 1: outstanding notional of instruments tied to b b A fixings
Speaker 1: is enormous, and I wrote, but enormous markets create enormous temptations.
Speaker 1: The CME argument works only to the extent that we
Speaker 1: rely on BBA members to look beyond their self interests. Again,
Speaker 1: without impugning any of the b b A banks, we
Speaker 1: do not consider this to be a sound basis for
Speaker 1: predicting human behavior. So I was a snarky little guy then,
Speaker 1: But well, obviously spot on two. But so in retrospect,
Speaker 1: obviously your argument, we'll get to the manipulation that did occur,
Speaker 1: But in retrospect the issues that you highlighted back then,
Speaker 1: they're like, oh, yeah, it seems obvious the potential for
Speaker 1: manipulation to make trades go one way, and a bank
Speaker 1: facing funding stress isn't going to want to put an
Speaker 1: accurate number on a survey in which the survey is
Speaker 1: not anonymous, So that all seems like obvious in retrospect.
Speaker 1: Why wasn't this a source of concern from the very
Speaker 1: beginning or while? Because? Yeah, why weren't there more worried
Speaker 1: about that? Because it seemed to be working? Uh, it was.
Speaker 1: The derivatives market was growing, that forward rate agreements, which
Speaker 1: are tied to live or were growing. Um, the whole
Speaker 1: market was centered on live ar was expanding to sixteen currencies.
Speaker 1: It's I think you have to wait for something bad
Speaker 1: to happen before you can disrupt a force like that
Speaker 1: sounds like how the world works, and I'm afraid it does. Yeah.
Speaker 1: Did anyone from the c f TC get back to you? Yeah,
Speaker 1: they got back to me. As I recall, they said
Speaker 1: they worked at a daylet it was a business decision,
Speaker 1: and they gave me a sweatshirt. They gave you a sweatshirt.
Speaker 1: Do you still have it? Oh? Man? That that that
Speaker 1: was That was the outcome. Ah, I love that detail. Um.
Speaker 1: So obviously librar continued to grow by the time, you know,
Speaker 1: fast forward a few years, by the time we get
Speaker 1: to the financial crisis and when the Shenanigan started to
Speaker 1: be uncovered. How much of the world credit markets and
Speaker 1: how much was linked then to this one index. You know,
Speaker 1: they say that US dollar libar has a four dred
Speaker 1: and fifty trillion dollar footprint right now. It's probably about
Speaker 1: the same at the time if you count your at
Speaker 1: dollar futures, corporate loans, all loans are tied to live bar.
Speaker 1: This is just dollars and it's probably just as big
Speaker 1: in euros tied to your eye bar um, British poems, yeah,
Speaker 1: Swiss frank and many other currencies at the time. So
Speaker 1: the number safe something. I mean, if you count every
Speaker 1: year at all our futures contract you get to quite
Speaker 1: lofty numbers. I mean adding them all together is is
Speaker 1: in a way kind of buff fishy. But that's that
Speaker 1: it's huge by by any standards of hugeness, it's huge.
Speaker 1: So if we fast forward to two thousand eight or
Speaker 1: two thousand nine, as far as I can remember, the
Speaker 1: charges of liborary manipulation or the rumors of liborary manipulation
Speaker 1: started surfacing in the financial media I think in early
Speaker 1: two thousand nine, and you sort of got a steady
Speaker 1: drip of allegations of certain behavior. What did you think
Speaker 1: in those days watching this where you just sort of
Speaker 1: sat in your office, going, see, I told you so hopefully. Uh,
Speaker 1: in those days I had other things, um problems of
Speaker 1: my own at that moment. There's a key turning point
Speaker 1: in the first quarter of two thousand and eight in
Speaker 1: understanding what happened to Liebor, we have to recognize the
Speaker 1: change in the policy of the Federal Reserve to start
Speaker 1: paying interest on access reserves that banks held at the FED.
Speaker 1: Banks would the starting in in Q one O eight um.
Speaker 1: The Fed would pay at the top of its target
Speaker 1: at at its target rate, and then later at the
Speaker 1: top of its target range money that banks left at
Speaker 1: the fat So why would I lend to another bank
Speaker 1: when I could just leave the money at the Central
Speaker 1: Bank and get a generous interest rate, I wouldn't. So
Speaker 1: as a result of that, library became unhinged to anything
Speaker 1: that was happening in the world. Two thousand seven. It's
Speaker 1: not not to do with the financial crisis. Is just
Speaker 1: a change that Bernanke had planned for a long time
Speaker 1: at the Federal Reserve. So the interbank, the ib and
Speaker 1: the liebar vanished. So it left banks to really guess
Speaker 1: what they might borrow if they were to borrow, even
Speaker 1: though they hadn't borrowed no long time. There's a year's
Speaker 1: roll by. It became, you know, the individuals at the
Speaker 1: banks responsible for submitting the uh libar each day would
Speaker 1: just uh, you know, imagine what they might have done
Speaker 1: if an interbank market still existed, but it didn't exist.
Speaker 1: Talk to us a little bit more about the process
Speaker 1: back when it had existed and then didn't. So the
Speaker 1: survey says, what do you think that you could borrow
Speaker 1: at if you weren't negotiating? What would you be offered at?
Speaker 1: What was the actual process within a generic bank, someone's
Speaker 1: job was to come up with that number. How would
Speaker 1: they have done that? And then how did that change
Speaker 1: once that market disappeared. I can only speak from my
Speaker 1: own bank at the time. We would wait. There was
Speaker 1: a bank called Fujibank that would submit it, and you
Speaker 1: could see their submission, and we would wait and do
Speaker 1: something close to their What they actually did at Fujibank,
Speaker 1: I don't know, but it would. It would pretty much
Speaker 1: be based on at the time on what the overnight
Speaker 1: rate was, plus an expectation for what the overnight rate
Speaker 1: would average over the term because borrowing overnight overnight rolling
Speaker 1: it for ninety days is a substitute for borrowing for
Speaker 1: ninety days at a term rate. So more or less
Speaker 1: be the bank's estimate of what they expected from the
Speaker 1: Federal Reserve over the three month period, and then a
Speaker 1: little bit more because it was the offered side the
Speaker 1: o r. And then if there were some liquidity premium,
Speaker 1: some pressures on term funding, some extra compensation that a
Speaker 1: bank would be willing to pay for having the money
Speaker 1: for three months or six months, then they would tack
Speaker 1: on a basis point or two for that. But it
Speaker 1: was that was actually very small. So it's really just
Speaker 1: what do we think the overnight rate will average during
Speaker 1: this time, um us a little bit for the offered side,
Speaker 1: and that that was how it worked. Could you walk
Speaker 1: us through the exact motivations for manipulating library because and
Speaker 1: and specifically the motivation for manipulating librar higher because I
Speaker 1: think a lot of people will understand that. You know,
Speaker 1: you might low ball the number because you don't want
Speaker 1: to out yourself as having a higher rate of borrowing
Speaker 1: in the inter bank market than some of your other
Speaker 1: bank peers. But why would anyone want to manipulate the
Speaker 1: rate higher? How did that work? Okay? There are two
Speaker 1: classes of manipulation here. The first is if you're receiving
Speaker 1: or making a payment tied to libor, you might if
Speaker 1: you're making a payment, you would like it a little lower.
Speaker 1: If you're receiving a payment tied to live or, you
Speaker 1: would like it to be a little higher. Now, you
Speaker 1: might be making a payment or receiving a payment depending
Speaker 1: most likely tied to an interest rate swap. So in
Speaker 1: an interest rate swap, a bank will pay fixed and
Speaker 1: receive a sequence of payments based on live or or.
Speaker 1: If it's um receiving a fixed rate, it will make
Speaker 1: payments tied to live or. So it's completely symmetrical that way.
Speaker 1: There may be days when a bank has a big
Speaker 1: live or fixing on an interest rate swap where it's
Speaker 1: receiving fixed and would like it to be a little higher,
Speaker 1: or days when it's paying fixed and would like it
Speaker 1: to be a little lower. That's that's kind of a
Speaker 1: micro manipulation. And then there's the other there's there's the
Speaker 1: signaling effect where it would like to create lower It
Speaker 1: doesn't want to stand out from the crowd if there's
Speaker 1: suspicion that it has um funding problems. The so called
Speaker 1: Live War scandal was the first kind of manipulation where
Speaker 1: banks would presumably change their rate based on what was
Speaker 1: going to happen on their self interest at that day. Now,
Speaker 1: you mentioned in the beginning, I think you said they
Speaker 1: pulled twenty banks. They lop off the top four and
Speaker 1: they lop off the bottom four. So that makes it difficult,
Speaker 1: of course for anyone bank to manipulate uh the underlying
Speaker 1: price because you could post something extreme in one direction,
Speaker 1: but they'll just lop it off. This gets to where
Speaker 1: there must have been and there was an element of collusion. Okay,
Speaker 1: I don't believe I agree with your your statement that
Speaker 1: it's hard to move the rate by very much. So
Speaker 1: you know, a bank like Barclays might move the rate
Speaker 1: by let's say eight basis points, and they can still
Speaker 1: not be lopped off. Let's take the case where they're
Speaker 1: Let's suppose that they're able to move the rate by
Speaker 1: one basis point, right, I think that's possible acting on
Speaker 1: their own. Let's say that they're receiving a five billion
Speaker 1: dollars set. They're receiving that, and they can make the
Speaker 1: dollar reset for three months, So that's twenty one basis
Speaker 1: point on a million dollars is so in five million,
Speaker 1: it's a hundred and twenty five thousand dollars. So if
Speaker 1: they can move it up by a basis point, which
Speaker 1: would be heroic for them to do that, they could
Speaker 1: Yet they could make a hundred and twenty five dollars,
Speaker 1: So you know, this has been called Rolling Stone called
Speaker 1: this the scandal of all scandals. Some UH publications called
Speaker 1: this the greatest crime of the twentie century. I don't
Speaker 1: know what the greatest crime of the twentieth century is,
Speaker 1: but I don't think it's this. I mean, I think
Speaker 1: it's small change that the manipulation that they were able
Speaker 1: to affect and collusion, you know, I don't believe that
Speaker 1: there was collusion. I don't know that, but would be
Speaker 1: very hard. If any collusion were to happen, it would
Speaker 1: be orchestrated by the brokers. Okay, eye cap has been
Speaker 1: implicated in this, but since banks have competing interests every day,
Speaker 1: the idea that they all want a high set on
Speaker 1: this particular day, it is unlikely. Um So, you know,
Speaker 1: if under a lot of money, but it's not not
Speaker 1: a lot of money to someone in trading gigantic swamps book,
Speaker 1: So I think, uh, I think it was kind of
Speaker 1: acute and for them, acute and small time crime. What
Speaker 1: made this really scandalous? First couple, for a couple of reasons.
Speaker 1: It is scandalous. First, the email traffic is is really embarrassing,
Speaker 1: the famous I'm opening a bottle of Bolinger Champagne emails
Speaker 1: and that sort of thing. And he it was actually
Speaker 1: Cure Curry that they were getting once his credit card
Speaker 1: was retired. And then he wrote anything for you, big boy.
Speaker 1: And I also believe, you know, if I think a
Speaker 1: lot of this was just bluster, I'm not sure. You know,
Speaker 1: I'm not sure that as much happened as the broker
Speaker 1: might say. You know, I'll arrange this for you, big boy.
Speaker 1: And then not do it, and then if the rate
Speaker 1: went the way that they were hoping, they would take
Speaker 1: credit for it. I think there was plenty of that
Speaker 1: going on. This gets to one of my very my
Speaker 1: side issues that has almost nothing to do with finance
Speaker 1: per se, which is that all of our emails, in
Speaker 1: texts and direct messages look a lot worse than reality
Speaker 1: because people just talk and they blust her, they b
Speaker 1: s and they brag, and then if any of us
Speaker 1: were to have all of our private correspondence is dragged
Speaker 1: out in a court of law or in the media,
Speaker 1: it would look pretty terrible. That's just a general belief
Speaker 1: beyond any sort of uh, you know, fixing of an index. Yeah,
Speaker 1: and I think people are more careful as a result
Speaker 1: of this scandal because it blew up. You know, part
Speaker 1: of there's a second scandal are there's a lot of
Speaker 1: blame to go around here, and the other scandal is
Speaker 1: paying interest on reserves for the Central Bank and then
Speaker 1: not doing anything to fix live lary. This should have
Speaker 1: been done in two thousand seven. This was because how
Speaker 1: can you continue to use as a centerpiece of three
Speaker 1: month right that doesn't exist anymore? So if the fundamental
Speaker 1: process of setting library via survey just continued on even
Speaker 1: after the interbank market de facto ended with the payment
Speaker 1: of interest on access reserves. Is there anything visible in
Speaker 1: the data that shows weirdness, Like did the dispersion of
Speaker 1: inputs start to change because the numbers became more fictitious
Speaker 1: and made up? Like there' is there a way to
Speaker 1: sort of if you look at it forensically, could you
Speaker 1: see something happened at that switch? I don't think so.
Speaker 1: You know, the groups were moving in a pack so
Speaker 1: they could see each other. Um, I think you know
Speaker 1: FED funds the overnight market, the domestic market also basically vanished,
Speaker 1: so there's still a FED funds index. You may wonder
Speaker 1: who which banks are lending to each other overnight? And
Speaker 1: that became the only banks that would lend in the
Speaker 1: inter bank market for FED funds became federal home loan
Speaker 1: banks that offered reserve pulling services for their member banks
Speaker 1: that didn't have access to the Federal reserve, So it
Speaker 1: just became a very small market. They couldn't lend at
Speaker 1: the FED, so they would they would lend to Japanese
Speaker 1: banks that didn't have to pay deposit insurance. That would
Speaker 1: turn around and put the reserves at the at at
Speaker 1: at the Federal Reserve. So it was it became a
Speaker 1: tiny market of about fifty billion dollars overnight after the
Speaker 1: first quarter of two thousand and eight. So I think
Speaker 1: the scandal became a maybe a catalyst too. Oh were
Speaker 1: Hall libar, But it had to be done eventually anyway,
Speaker 1: and I think it should have been done a long
Speaker 1: time ago. I mean, from what I remember, there there
Speaker 1: was some academic research, I think from two thousand and
Speaker 1: eight where they did look into LIEBR submissions, and I
Speaker 1: think they did find some sketchiness. They're like some banks
Speaker 1: seem more inclined to quote higher than others um and
Speaker 1: it never came to a firm conclusion, but it sort
Speaker 1: of kicked off a lot of discussion. I was just wondering,
Speaker 1: as this came to light and as the allegations are
Speaker 1: sort of flying around post two thousand nine, were you
Speaker 1: surprised at all by the reaction of the British Bankers
Speaker 1: Association because they defended the libar process to the very end.
Speaker 1: Maybe you know, that was a prestigious thing for them,
Speaker 1: it was what they were known for, but they there
Speaker 1: was not a role for them, um post not post crisis,
Speaker 1: but post in dollars post the first quarter of two
Speaker 1: Alston tonight. Um, So I guess it's I guess it
Speaker 1: shouldn't come as a surprise that people want to hang
Speaker 1: onto their power. So talk to us a little bit
Speaker 1: more about the other form of manipulation in that significance. So,
Speaker 1: as you mentioned, there was the attempts to adjust the
Speaker 1: rate for perhaps to gain a little bit of an
Speaker 1: edge on a trade, or maybe to convince a client
Speaker 1: that you've done something really big for them. But as
Speaker 1: you put it, it is a scandal, but probably not
Speaker 1: the greatest scandal of the century or the biggest crime
Speaker 1: or the biggest swindle ever. But what about this other
Speaker 1: part of the significance, or the degree to which banks
Speaker 1: disguise their funding weakness just by submitting false bits. Yeah,
Speaker 1: I'll say one one thing on behalf of the banks.
Speaker 1: Let's let's consider September two thousand and eight, on the
Speaker 1: Monday when Lehman went into administration. Okay, the question becomes,
Speaker 1: if you were to go and borrow UH for three
Speaker 1: months six months from another bank without negotiating, what right
Speaker 1: would you get? Now? On that day, Goldman Sachs and
Speaker 1: Deutsche Bank wouldn't settle spot for in exchange with each other.
Speaker 1: So if you were to call another bank and asked
Speaker 1: to borrow for three months and not negotiate, the answer
Speaker 1: would be infinity. Okay, there's no responsible thing to do
Speaker 1: because this in this question that you're being asked is
Speaker 1: posed for a different environment, for a different background. So
Speaker 1: the question, just the grammar of the question doesn't make
Speaker 1: any sense, and you have to give something, so, you know, makeup.
Speaker 1: If they put you a million percent or a thousand percent,
Speaker 1: then they would have blown up all the derivatives of
Speaker 1: the world and all the home mortgages and all the
Speaker 1: floating right does so they just put something. Famously, Barclays
Speaker 1: was putting a higher rate in dollars than other banks,
Speaker 1: and Paul Tucker at the Bank of England told them
Speaker 1: to lay off a little bit because you're you're freaking
Speaker 1: people out. I'm paraphrasing, and you know he was criticized
Speaker 1: for that, but you know, in the context of the time,
Speaker 1: it was sort of a grown up thing to do
Speaker 1: because nobody's the whole thing is is divorced from any
Speaker 1: kind of reality. People have to muddle through because the
Speaker 1: index was not constructed for this environment. So I'm not,
Speaker 1: you know, sure what else to do. Well, it just
Speaker 1: to be clear, in mid September, it's not like there
Speaker 1: was a lot of mystery that the banks were under
Speaker 1: a lot of stress. So even if to the degree
Speaker 1: that they may have been making things up, it's not
Speaker 1: like people were under some illusion that they were all
Speaker 1: in great health, right I I I don't think it
Speaker 1: was shocking. I think looking at the details of the
Speaker 1: live or submissions and trying to read anything into that
Speaker 1: was a hopeless exercise. So it would probably be overegging
Speaker 1: it to say that actually giving the banks a degree
Speaker 1: of control over their self reported borrowing rates might have
Speaker 1: been a good thing in September two tho eight, or
Speaker 1: at least gave them a little bit of leeway. But
Speaker 1: I think that's a good segue maybe to talk about
Speaker 1: the transition away from ybor Um. And I think the
Speaker 1: effort is mostly to again move away from this self
Speaker 1: reported survey and go back to a reference rate that's
Speaker 1: based on actual transactions. What do you think about that move? Yeah,
Speaker 1: I think the move to SOFA which we have in
Speaker 1: the United States is the right one. It's based on
Speaker 1: actual transactions secured overnight financing. The and we should point
Speaker 1: out in other currencies the move has already been made
Speaker 1: in Australia to bank bills, in Canada to see daru,
Speaker 1: the New Zealand Danish krona, they've all made the transition
Speaker 1: years ago to overnight secured right. And in Euros the
Speaker 1: move the equivalent to SOFAR is something called esther, the
Speaker 1: Euro short term interest rate UM, the and the E
Speaker 1: and esther is the euro symbol. And already the overnight
Speaker 1: interest rate called the one A in Euros has switched
Speaker 1: to ESTHER plus a spread and that's produced by the
Speaker 1: ECB every day. UM. The SOFA is based on secured
Speaker 1: overnight financing. So each day at eight o'clock UM, the
Speaker 1: PO Reserve publishes the average repo rate or secured financing
Speaker 1: that was reported to them from the previous day, and
Speaker 1: it's a it's a volume weighted median. So you throw
Speaker 1: out all the top and all the bottom, and look
Speaker 1: what's in the middle, and uh so it's it's an
Speaker 1: overnight rate. And then the the issue that the market
Speaker 1: has to confront is how to turn an overnight right
Speaker 1: into a three month rate or a six month rate
Speaker 1: in order to create new contracts and also to switch
Speaker 1: over all the legacy contracts. Okay, uh, Richard, we're going
Speaker 1: to stop it there, because we're going to devote at
Speaker 1: least I think two more episodes into really delving into
Speaker 1: the technicalities of sofer and other replacement rates for libor.
Speaker 1: But thank you so much for coming on. That was
Speaker 1: a really fantastic conversation. Thanks, thanks, Thanks Trisy, It's a pleasure.
Speaker 1: So Joe, do you feel do you feel more up
Speaker 1: to speed on the Librar series? Yeah? That was actually
Speaker 1: incredibly helpful. Um I had only the most vague outlined,
Speaker 1: but just really walking through the mechanics of how they
Speaker 1: constructed it, how the manipulation worked, a degree of it,
Speaker 1: why the world credit markets less around it, I found. Uh.
Speaker 1: I feel like as we continue with this series, I
Speaker 1: feel a little bit more on firmer footing than I
Speaker 1: did a little while ago. Yeah, and I think Richard
Speaker 1: is really good at getting to the nuance of a
Speaker 1: lot of this topic, like the differences in manipulation, why
Speaker 1: people did what they did, and also the degree to
Speaker 1: which it was a scandal or not, because, of course,
Speaker 1: if you're manipulating the reference rate for trillions of dollars
Speaker 1: worth of financial assets one basis point or another. It
Speaker 1: is going to have an impact on the overall market,
Speaker 1: but your actual profit from that move is probably not
Speaker 1: going to be that huge. Yeah, exactly right, And uh,
Speaker 1: it's great to hear from someone who, like ten years
Speaker 1: before everyone to agree or recognize that the system was flawed.
Speaker 1: Seemed to nail it exactly. It's only too bad that
Speaker 1: he didn't keep that sweatshirt. Yeah, it sort of speaks
Speaker 1: to what's the word I'm looking for, systemic complacency. I
Speaker 1: think people always knew that there was a possibility a
Speaker 1: survey of self reported borrowing costs from the banks could maybe,
Speaker 1: uh not necessarily reflect reality all the time, and people
Speaker 1: chose to overlook it because libor was easy for them,
Speaker 1: It was standardized at that point, and frankly, it was
Speaker 1: profitable and linked to lots of different financial instruments, from
Speaker 1: euro dollars to interest rate swaps. Yeah, exactly right. All right,
Speaker 1: should we leave it there? Yeah, we have lots more
Speaker 1: to talk about in our next episode. This has been
Speaker 1: another edition of the All Thoughts podcast. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway. I'm
Speaker 1: Joe Why Isn't All? You can follow me on Twitter
Speaker 1: at the Stalwarts, and you can follow our producer on Twitter,
Speaker 1: Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg
Speaker 1: Head of Podcasts, Francesca Levy at Francesca Today, and check
Speaker 1: out all of our podcast at Bloomberg under the A
Speaker 1: handle at podcasts. Thanks for listening.