How do you solve Libor problem?
The Australian
Richard Barley, The Wall Street Journal
Friday July 6, 2012

PHYSICISTS may have tracked down the Higgs boson, key to understanding how the universe is built. But for a real challenge, consider that facing Martin Wheatley.

The chief executive-designate of the new UK Financial Conduct Authority is to review the setting of Libor, the London interbank offered rate at the heart of the Barclays scandal. Changing Libor could be tricky, not only because it underlies hundreds of trillions of dollars of loans, bonds and derivatives, but because of practical credit-market problems.

Libor and its European cousin Euribor are to some extent artificial constructs, particularly following the financial crisis. Nearly four years ago, Bank of England governor Mervyn King said Libor was "the rate at which banks do not lend to each other". Libor's overseer, the Foreign Exchange and Money Markets Committee and the British Bankers' Association, announced an overhaul of Libor in November 2008 after questions were raised about its accuracy. Tellingly, they left unchanged the way in which it is determined.

The Libor survey asks banks at what rate they could borrow unsecured funds were they to do so; the European Banking Federation's Euribor survey asks at what rate banks believe prime banks are lending to each other. Both are, therefore, perceived rates, not tied to actual deals.

The 2008 Libor review concluded that individual deal rates couldn't be used due to confidentiality rules. The huge deterioration in banks' credit-worthiness since then complicates the situation. Unsecured bank lending before the crisis was seen as low-risk, and credit risk was homogenous. Now, banks have disparate credit ratings and risks. Much lending is now on a secured basis and funneled via central banks.

It can be difficult to determine accurately the market price of lending. In many parts of the debt market, apart from ultraliquid products like Treasurys, pricing often is indicative. Libor generates 150 rates daily, covering 10 currencies and 15 maturities. In any one day, the likelihood that banks will have traded all of these to generate a rate submission is low.

But because mortgages and loans are linked to Libor, and will be for years to come, Libor still is vital. Borrowers have benefited from extremely low levels of Libor: Three-month dollar Libor stands at 0.46 per cent and three-month Euribor at 0.65 per cent. Arguably, overhauls to make Libor more reflective of reality could lead to higher rates that may be more volatile, setting another obstacle on the road to recovery. Potential alternatives like repurchase-agreement rates or overnight index swaps aren't exact substitutes for Libor, which may cause distortions if they were used as a replacement.

Like the Higgs boson, Libor is a fundamental building block for the financial universe. Its governance clearly needs to be improved, but markets may have to continue to live with its mysteries

Rough day for Diamond as Libor scandal spreads
David Enrich, Sara Schaefer Munoz, The Wall Street Journal

LONDON — A day after abruptly resigning amid a mushrooming scandal over interest-rate manipulation, former Barclays chief Robert Diamond on Wednesday was assailed by British lawmakers for the bank's actions, in a preview of the scrutiny likely to lie ahead for other big lenders that are under investigation. Barclays last week agreed to pay $US453 million to settle US and British authorities' allegations that the British bank tried to manipulate the London interbank offered rate, or Libor, which is the benchmark for interest rates on trillions of dollars of loans to individuals and businesses around the world.

Barclays executives initially believed they could ride out any resulting fallout from the settlement and accompanying admission that Barclays had acted improperly. But by Tuesday, the scandal had prompted the resignations of Mr Diamond, Barclays Chairman Marcus Agius and Chief Operating Officer Jerry del Missier, some of the British banking industry's most prominent figures. No individuals were charged.

With British politicians on all sides calling for further investigations, Mr Diamond faced hostile questions from a parliamentary committee. Lawmakers expressed skepticism about his claim that he wasn't aware until recently of his subordinates' improprieties. "Either you were complicit, grossly negligent or incompetent," John Mann, a Labour lawmaker, told Mr Diamond. After a pause, Mr Diamond asked, "Is there a question?"

The Libor affair isn't solely a Barclays problem. In the UK, the scandal has quickly touched other top figures in the British political and finance establishment. That is partly because Mr Diamond sought to deflect some of the blame by saying that Mr del Missier, one of his deputies, believed that by lowering Barclays's Libor submissions he was acting at the behest of a top Bank of England official, Paul Tucker. That allegation is explosive, since Mr Tucker has been regarded as a front-runner to become the central bank's next governor.

Barclays won't be the only bank put through the wringer over the question of Libor manipulation, which first emerged as an issue four years ago when a series of Wall Street Journal articles raised questions about possible fudging involving the interest-rate benchmark. Libor, a measure of how much banks have to pay to borrow from each other, is drawn up daily following submissions from a group of 16 giant banks, which report their borrowing costs for loans of different maturities and in different currencies.

Investigations of more than a dozen banks — by authorities on three continents — are starting to unearth evidence that some banks improperly sought to manipulate Libor. Regulators say that some banks, including Barclays, submitted artificially low readings during the early days of the financial crisis as part of an effort to mask the financial problems they were encountering.

Analysts say the industry may have to shell out billions of dollars to settle the cases and other bank chiefs could find themselves in the cross hairs. Wednesday's three-hour parliamentary hearing didn't yield much new information about what some industry executives say was a widespread practice of submitting faulty Libor data. It also didn't fully clarify the roles played by Mr Tucker or British government officials. Instead, the hearing was an opportunity for members of Parliament — including two former Barclays executives — to tear into Mr Diamond. Even before becoming CEO at the start of last year, the American-born executive had been a popular British punching bag, thanks to his sometimes-brash manner, his investment-banking pedigree and his history of pocketing huge bonuses.

At Wednesday's hearing, Mr Diamond repeatedly condemned the "reprehensible" behavior of a few employees, saying, "It puts a real stain on the organization." But he argued that their actions shouldn't undermine the entire company. His explanations were rejected, as was his protocol. One lawmaker, Teresa Pearce, tweeted: "Really annoying that Mr Diamond is using our first names. so rude."

Besides roiling London's tightknit financial hub, the fracas highlights the power the British government continues to wield over the financial sector, years after taking partial control over two teetering lenders. Barclays's chairman, Mr Agius, announced his resignation Monday in an attempt to defuse the billowing political outrage. That evening, the governor of the Bank of England and the chairman of the Financial Services Authority each contacted Mr Agius. They both delivered the message that Mr Diamond needed to step down to restore confidence in the bank, according to people familiar with the matter. Mr Diamond resigned early Tuesday.

Barclays is the only bank so far to resolve Libor-fixing allegations, but roughly a dozen banks have acknowledged being under criminal or civil investigation in various countries in the matter. In its settlement with US and British authorities, Barclays acknowledged that, starting in 2005, traders submitted erroneous data about its borrowing costs, in what was then an effort by some employees to boost profits on the positions they held. Regulators uncovered emails, instant messages and phone calls in which Barclays traders and other employees openly discussed their tactics.

But by 2008, with the financial crisis intensifying, Barclays was routinely submitting some of the highest cost-of-borrowing readings of any bank. Executives at Barclays, which was financially healthier than some banks that were reporting lower borrowing costs, believed this was because rivals were reporting bogus data to conceal their financial problems. Mr Diamond and other executives repeatedly complained to regulators.

Barclays officials had hoped that by settling early, they would win praise for full cooperation and for resolving uncertainty about the potentially hefty price tag of any settlement. Mr Diamond and his circle thought the story could fizzle after a single news cycle, according to people familiar with the matter. Some board members were especially hopeful because Mr Diamond and three top lieutenants agreed, as part of the settlement, to forgo their 2012 bonuses.

It was a familiar attitude to some Barclays executives, who coined the term "Bob-timism" to reflect their boss's eternally upbeat perspective. Just five days before the settlement, Barclays promoted an investment-banking executive, Mr del Missier, to chief operating officer. The FSA signed off on the promotion. On Tuesday, Mr del Missier, now publicly identified as being at the center of the Libor scandal, resigned.

** End of report