Bernanke's Libor Alternatives

Tyler Durden's picture

Via Stone & McCarthy,

Libor is not a market determined interest rate, rather it is a trimmed mean from a survey of banks participating in a survey conducted on behalf of the British Bankers Association (BBA). There are a number of problems inherent in the survey-based Libor calculation.

First, there is the stigma associated with a higher than average Libor posting. This stigma results in an under-reporting of Libor. Banks that submitted Libor postings above the average submission, risked being punished by speculators, depositors, and other creditors including other banks. This dynamic rendered a "gaming" of submissions that rendered an understandable under-representation of Libor.

The Fed as well as most market participants were aware of this problem back in 2008. See: Everyone Knew, Not Just FRBNY, Banks Underreported Libor (Stone, July 13, 2012)

Second, there have been incentives for banks to attempt to manipulate Libor by submitting Libor postings that would alter the trimmed mean. The ethics of such manipulation is materially different than the aforementioned stigma associated under-representative of Libor. Here the manipulation was an attempt to foster Libor rates that enriched trading operations of the submitting bank.

Bernanke Alternatives

Chairman Bernanke was asked in testimony several times yesterday whether Libor should be dropped as a benchmark interest rate. His answer was Libor should be repaired or some market determined interest rate should be embraced as an alternative.

He offered up 2 market-determined replacement possibilities for Libor:

(1) Repo Rates
(2) OIS rates

Both are market determined interest rates, but neither in our minds captures the essence of what Libor is supposed to measure. For example, dollar Libor is suppose to measure the cost of unsecured interbank borrowing of dollars by a subset of banks in London. Effectively, this is the eurodollar rate for these banks.

Our preference for a Libor alternative would simply be the eurodollar rate. The Fed publishes this rate daily. The Fed's source for the eurodollar rate is the ICAP eurodollar screen on the Bloomberg at 9:30am eastern time each morning. Certainly, if timing is an issue, a 6:30am snapshot could be taken to be more closely aligned with the timing of current Libor snapshot.

Why Not Repo Rates?

Repo rates represent the cost of secured funding as oppose to unsecured. Repo rates are subjected to issues surrounding dealer positions, the availability of repo collateral, and do not necessarily reflect the cost of unsecured funds to banks.

Why Not the OIS Funds Rate?

The OIS funds rate is simply the implicit expected average funds rate based on the fixed side of a swap agreement. Importantly, the funds rate is not the same as the cost of dollar deposits to banks outside the US. It was for this reason that the Libor-OIS spread and the eurodollar-OIS spread enlarged dramatically during the dark days of the financial crisis.

While the funds rate does represent the cost of unsecured inter-bank funding amongst US banks, it is below that paid be banks outside the US if for no other reason than US banks have direct access to the liquidity safety net provided by the Fed's discount window. Not all banks operating in London have even indirect access to the Fed's discount window.

The Fed effectively targets the overnight funds rate, and the term OIS funds rate is in concept a construct that should mirror something close to the average expected funds target over the specified term. In concept the term eurodollar rate is the expected average overnight eurodollar rate over the term. But the difference between the funds rate and the eurodollar rate reflects both perceived credit risk, and bank funding needs.

When banks outside the U.S. find themselves with increased term-dollar funding requirements, or stains due to balancing sheet dressing by US Money Market Funds associated with quarter or year-ends--the eurodollar rate will go up, not necessarily so for the overnight funds rate or the 1-mo, 3-mo, etc OIS funds rate.

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buzzsaw99's picture

Buying IR swaps from the same maggots who set LIBOR is as stupid as buying TIPs from the maggots who set the cpi. Make your best deal and live with it, that's my advice.

vast-dom's picture

but bernankzi does NOT believe or do market determined.


put another way: asking a central planner about market determined is like expecting an honest answer from a patholigical liar.

buzzsaw99's picture

They could use a chicken to set LIBOR like they do everything else:

FieldingMellish's picture

When I saw that episode I told my kids that's a lot closer to the truth than they know.

Precious's picture

The red pill or the blue pill.

FieldingMellish's picture

I wonder what would happen if you took both? Unfortunately, my pill experimentation days are behind me... at least I think they are.

Gadocat99's picture

Why not rely on capitalism?

LawsofPhysics's picture

You couldn't have taxpayer bailouts of private companies run by politically connected people then.  The owners and management would have to pay back the creditors in default.  Fascism and crony capitalism doesn't allow for such things.  Let the serfs pay - socialization of losses, capital and resouce misallocation at it's finest.  The U.S.S.A and U.S.S.R. going to the same place from different directions. 

lolmao500's picture

The engineered economic crisis won't matter soon enough...

RT @SpiritRider1: Channel 2 #news in #Israel reporting #Syria regime passing it's soldiers chemical weapons to be used against own citizens!! #PrayforSyria
El Oregonian's picture

You'd have better results throwing darts at a board...

FieldingMellish's picture

Or monkeys.. oh wait.. they tried that already.

The Proletariat's picture

Bernanke is like the gay guy in the bathtub that enjoys getting pissed on by Obama, Bush, Clinton, Dimon, etal......



(in memory of Bill Hicks)

ShorTed's picture

LIBORs fault is that the submitters are asked to post interest rates where various tenors are (allegedly) offered to them by their BBA peers.  Perhaps turning the tables would make it a bit more honest...where would the submitter lend money to those BBA peers in each tenor?

Al Huxley's picture

it is a trimmed mean from a survey of banks participating in a survey conducted on behalf of the British Bankers Association (BBA).

Really? I thought it was a scheme cooked up by insiders in the banks so they could manipulate markets and generate risk-free trades and fat bonuses for themselves.  So your definition is different than mine.

neutrinoman's picture

Good article -- capitalism indeed.

LIBOR was an outgrowth of the old eurodollar/TED spread complex. It started in the late 60s, when international dollar shortage (and US trade surpluses) gave way to more or less permanent trade deficits and dollar glut. Lots of dollars ended up in London and in Europe, as dollars were being emitted in the Great Inflation, mainly to pay for oil imports. This faded in the 80s and part of the 90s. But it came back in the later Greenspan and the Bernanke years, as the US started emitting more surplus dollars again.

The eurodollar rate is the origin of this idea, and it is a market rate -- so why not?

P.S. LIBOR gave up the ghost starting in the late summer of 2007 and was defunct by late 2008. Now it walks around in a truncated form and is meaningful only for short-term interbank lending (less than a month, and mainly overnight). Banks no longer trust one another to lend to each other for any longer. LIBOR rates over a month duration, quoted since fall 2007, have necessarily been fictions. They're not "manipulated"; they're just made up.

Al Huxley's picture

And further to my previous comment, does it really matter to the rest of us which rate those corrupt manipulative fucks at the bank use to lie, steal and enrich themselves at the expense of the general public?  Is it somehow better for me if they fuck me using the repo rate, the OIS funds rate, or any other rate that they cook up with the idea of stuffing money into their fucking pockets? 

FieldingMellish's picture

Its simply a matter of choosing the orifice. The end result is the same.

kraschenbern's picture

But less painful with vaseline?

q99x2's picture

Thems some slim pickens.

sitenine's picture

Why not just set it at 0 and walk away?

It's all going to end in a large heap of ponzi dust anyway.

oogs66's picture

Worst article ever. Seriously. Eurodollar rate is futures market based on where Libor will settle on future date?!!!!!!

AgShaman's picture

"So, we're going to begin the, I mean auction for the Greek Islands....

....and who would like to open the first bid for the Libor Alternatives project land sale?"

oogs66's picture

EDA contracts settle against BBA rate. This is either most sarcastic post ever, or jumping the shark

Mediocritas's picture

The only rate that matters is the discount rate. Everything else is shaped by that so there isn't much point arguing about what derivative measure should be used.

All the banks that matter have direct access to the discount window. For the few that don't, the Fed is more than happy to provide a workaround when required (as we've seen in the past), and that's true for alleviating liquidity problems in both the dollar and eurodollar landscapes.

Interbank rates are essentially meaningless, no matter which way you try to assess them. The Fed has ensured that any significant bank, anywhere in the world, can get access to more USD denominated reserves than they can poke a stick at. Unfortunately for the Fed, because the world is in a balance sheet recession, pushing more and more surplus reserves out there does absolutely nothing to stimulate the real economy, it just makes banks more confident to double their bets in the derivatives casino and blow up bigger next time.

The Fed, of course, doesn't really give a shit about the real economy because that's not the Fed's job. It's simply the peak union representative of the banking sector and acts primarily in the best interests of its members.

cowdiddly's picture

Bernanke wants a market determined rate. LOL how supid are you, you ignorant bearded douchbag. You have your fat ham fist in every market so nothing can find its true value.

     Do they really expect us to buy in to this drivel?