I was wrong.
The process is like this:
“We had to fix a rate, so I called up all the banks and asked them to send to me by 11 a.m. their cost of money,” he said. “We got the rates, I made an average of them all and I named it the London interbank offer rate.”
For more than 15 years, the banks set the rate more or less as Mr. Zombanakis described — by throwing out the highest and lowest rates and compiling an average of the remaining ones.Self reported averages. Craziness! Just set them both to zero and be done with it.
Winter,
ReplyDeleteUnlike the case of Canada and maybe some other countries, there is some amount of fluctuation of actual lending/borrowing around the Federal Funds target even for overnight borrowing in the Fed Funds market.
(This is sometimes offered as a proof by people to show that the central bank doesn't have control on interest rates etc and they actually control the money supply!)
Because the monetary policy is known in advance a lot of times, borrowing rates such as the 3m rate etc are close this target.
In some cases there can be deviations of the 3m rate. e.g. suppose there are 3 meetings within the next three months. This causes some uncertainty. Will the Fed change in all 3 or just two of the three and by how much and so on. So 3m rates can deviate from the target.
Secondly, even if there is no crisis, banks were still seen to have a credit-risk - although the markets perceived it was low. Still, one more factor for a deviation from the target.
So this gives a lot of room for banks to manipulate - and their report to the BBA could be biased and based on what there positions on what their positions were (such as on swaps).
During the crisis, the credit risks went up drastically and the rates such as 3m were quite different than the Fed Funds rate and the Fed Funds target rate. So even more room to manipulate!
Even during 2008, some analysts (from big banks themselves) started doubting the reporting of Libor.
Ramanan:
ReplyDeleteYeah, agreed.
I don't think interbank lending rates are a good way to judge what risks a bank is carrying
They don't even have to report real numbers. All they do is answer a hypothetical, "What would it have cost you to borrow blah-blah just before 11am if blah-blah." There is no such thing as getting it confirmably wrong.
ReplyDeleteWhat's the Headline here?
Self-Policed Bank Fiction Constructed of Made Up Numbers Goes Horribly Wrong as Banks Make Up Numbers!
???
Winter,
ReplyDeleteYou may be interested in John Carney's post
Libor Rates: A Readers Guide
http://www.cnbc.com/id/48100292
Btw there is an issue with posting here:
ReplyDeleteA lot of times, the "submit" button is missing/hidden/not visible.
Ramanan:
ReplyDeleteSorry you are having technical difficulties. It's all in Google's hands though, not mine.
I think I might turn off the option to comment on old posts, so maybe that's it?
Winter,
ReplyDeleteI think it's less to do with turning off the option. Maybe you need an update? I use Wordpress so I don't know how it works in blogspot. Maybe it's a version issue? The guys at MNE have a different look to the comments section.
To be more precise, when I hit "publish", it seems fine but when I meet the spam check, the Publish button is missing (Actually it is hidden).
It doesn't happen in all browsers but it varies. Sometimes Chrome works, sometimes IE and at other times Mozilla.
Ramanan:
ReplyDeleteBlogger/Google hosts the site entirely. I don't do anything to update it, all happens automatically on their side.