Counterundebunking Lieborgate, Loeb Award Winner Edition

Tyler Durden's picture

Back in January, an article by Reuters' head financial blogger on the topic of the Greek bond restructuring, which effectively said that Greeks have all the leverage, prompted us to pen Subordination 101 (one of the year's most read posts on Zero Hedge), in which we patiently explained why his proposed blanket generalization was completely wrong, and why litigation arbitrage in covenant heavy UK-law bonds would be precisely the way to go into the Greek restructuring. 4 months later, those who listened to us made a 135% annualized return by getting taken out in Greek UK-law bonds at par, whereas those who listened to Reuters made, well nothing. What is amusing, is that such examples of pseudo-contrarian sophistry for the sake of making a statement, any statement, or better known in the media world as generating  "page views", no matter how ungrounded in financial fact, especially from recent Loeb award winners, is nothing new. To wit, we go back to May 29, 2008 where courtesy of the same author, in collaboration with another self-proclaimed Twitter pundit, we read "Defending Libor" in which the now Reutersian and his shoulder-chipped UK-based academic sidekick decide that, no Carrick Mollenkamp and Mark Whitehouse's then stunning and quite incendiary discoveries on Liebor are actually quite irrelevant, and are, to use the parlance of our times, a tempest in a teapot. His conclusion: "What the WSJ has done is come up with a marginally interesting intellectual conundrum: why is there a disconnect between CDS premia, on the one hand, and Libor spreads, on the other? But the way that the WSJ is reporting its findings they seem to think they’re uncovering a major scandal. They’re not." Actually, in retrospect, they are.

Amusingly enough, Salmon's attempts at failed inductive reasoning were even more evident back in June 29, 2007 when he defended none other than the rating agencies against the late Mark Pittman's allegations that they are a driving power behind the subprime crisis, a fact now undisputed by anyone: "[Pittman] took a single, now-defunct criterion, applied it to a pool of loans, and came up with a highly contentious headline. Then, he buried his argument at the bottom of an extremely long article... It also looks very much as though Pittman is trying to play "gotcha" with the ratings agencies. And that really isn't helpful." The rest, as they say, is history. And actually what isn't helpful is that while there are those who are contrarian for the sake of the general public interest, there are those embedded within the establishment who are contrarian to the contrarians, for the simple sake of "stirring the pot", or as is again better known in the media world, as generating "page views"

But back to Libor, which per Salmon, was perfectly a-ok.

From Felix Salmon, May 29, 2008, highlights exposing complete lack of financial comprehension ours:

Defending Libor

Carrick Mollenkamp and Mark Whitehouse got some pretty heavyweight backing for their Libor investigation today: before running it on the front page of the WSJ, they got sign-offs from Darrell Duffie of Stanford, Mikhail Chernov of London Business School, and David Juran of Columbia. In the blogosphere, their findings have been received uncritically by Ryan Chittum ("Lying about Libor" is his headline), Angus Robertson, Paul Jackson, and others.

But Alea is not convinced at all, and neither is JP Morgan, and neither am I.

One thing I find extremely suspicious is the fact that the WSJ’s interactive graphic shows implied rates only back to August 2007, thereby only showing what’s happened since the credit crunch hit. If they went back further, their methodology might be exposed:

Pre-credit crunch, pre-August 9th 2007, when OIS-Libor spread was below 10 bp, the Journal calculation would have resulted in a “risk-free Libor” below the OIS fixed, a proxy for a risk-free rate.

What’s more, there are lots of places where banks actually borrow real cash, like the commercial paper market. Why would the WSJ try to use credit default swaps to gauge what cash borrowing rates should be, when they can look to something like the CP market instead? Clearly, I think, the answer is that the CP market wouldn’t give them the answer that they’re looking for.

Alea does a good job of explaining the theoretical weaknesses behind the WSJ’s methodology. But my gut reaction that the methodology is flawed was based on none of those. Rather, I mistrust any calculation which assumes that since last summer there has been a clean and predictable and precise relationship between cash credit products, on the one hand, and credit default swaps, on the other. Yes, Libor is a borrowing rate, and yes, there is some kind of credit spread baked in to it. But to assume that Libor equals a risk-free borrowing rate plus a default-risk premium is silly and simplistic – especially when you don’t back-test your model to a time when things were much less volatile.

It’s worth remembering that the interbank markets are based on long-standing relationships which are necessary to any smoothly-functioning financial system. Yes, Citigroup’s credit default swaps might be pricing in a relatively high probability of default, but that doesn’t mean that Citi’s counterparties will charge it a similar premium to insure against default risk, as the WSJ seems to think. Maybe they trust Citi more than the rest of the market does, or maybe they realise that any possible world in which Citi defaults is a possible world in which they’ve got much bigger things to worry about than their interbank lines.

Do I think that Libor is perfect? No. In this world, no spread measure is going to be perfect, especially at tenors of longer than a couple of weeks. But Libor is not nearly as flawed as the WSJ makes it out to be.

What the WSJ has done is come up with a marginally interesting intellectual conundrum: why is there a disconnect between CDS premia, on the one hand, and Libor spreads, on the other? But the way that the WSJ is reporting its findings they seem to think they’re uncovering a major scandal. They’re not.

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battle axe's picture

Crooks running the prison....

monad's picture

"In a jail, within a gaol, within a white free protestant maelstrom..." James Douglas Morrison, a poet

emersonreturn's picture

you are tired, sheeple, very tired, you are drifting off to sleep...everything is beautiful, you are perfectly safe, don't worry...

Henry Chinaski's picture

There is a hoax here somewhere.

slaughterer's picture

Draghi speech now: exactly  the same stuff as last week, to update all the banksters who were too toasted in the Hamptons to keep up with the state of decomposition in real-time.   EZ enters repetition compulsion phase, very close to death drive. 

NewThor's picture

I made a video to simplify the LIBOR scandal.

The question I want to know is WHY are they telling us now?

Stay ahead of the curve people.

NewThor's picture

When Caroline Hyde gets all passionate like Hermoine Granger,

I get the good tingles all over. 

TideFighter's picture

but, but, but....derivatives

LULZBank's picture

I hate it when financial collapse is interrupted by a weekend.

Cognitive Dissonance's picture

I hate it when my weekend is interrupted by financial collapse.

But maybe that's just me.

Mercury's picture

This may be a tempest in a teapot in the sense that Libor is way overdue for an overhaul (you probably couldn't kill it because so much is tied to it but it could be completely changed and still called "Libor") and this is/should be the straw that breaks the camel's back.  Like credit ratings, a huge infrastructure has grown up around Libor above and beyond the original scope and intentions of the thing and it's all turned into a bit of a shit show.


Since basically no one actually borrows at Libor the real market is effectively what the spread rate is at any given time. Libor could be just about anything and the money markets would adjust accordingly relative to that.

Weirdly, it seems that many/most contracts and securities referencing Libor define it only by pointing to the Bloomberg/Reuters/Telerate etc. services and saying: “it’s that number”.  If one wanted to manipulate Libor, those market data pages might actually be the weakest links.

In any case, since government/regulators obviously manipulate Libor (at least in times of market stress), maybe they should just set it directly like Fed funds and be done with it. Or, if they want it to actually reflect market forces, tie it to repo rates or something...

the not so mighty maximiza's picture

800 trillion has been effected by the liebor scandal.  I would not call this a non event.

LULZBank's picture

Its not a question of what is effected but who is effected. get on with the programme.

lizzy36's picture

Deference to Pedigree.

That is what the fish won the Loeb for. It is what keep the status quo the status quo......deference to pedigree. If Larry Summers "smartest man in any room" said it is must be meritorious. It is what got Geithner a promotion after failing as the head of FRBNY.

Deference to Pedigree.

bigwavedave's picture

Felix (a cat) Salmon (a fish) .... sounds like a cover name for someone at the financial division of the NSA

Zero Govt's picture

Rothchild carrier pigeon, sorry Reuters, is having problems getting the staff (crones)

what we clearly need is some competition to shake up the cozy cartel of Reuters and Associated Press ...competition produces quality, cartels produce garbage

Vince Clortho's picture

"... competition produces quality, cartels produce propaganda."


good Post.  I tweaked your last line.

Meesohaawnee's picture

WSJ has become, or has been as totally irrelevant as Barrons.. I mean come on. Look who owns them. The non market stories are worth a gander but as far as hard hitting market news. Forget it. A Pointless candy coat.

ItsDanger's picture

Many of these articles still dont explain the mess clearly enough.  Its possible to agree on a higher rate yet not borrow/lend anything yet earn more and more money off customers.  This needs to be quantified in vastly more detail.

Apocalicious's picture

Ad hominem attacks accomplish nothing, but seriously, Felix Salmon is a friggin' idiot. He's like 12 years old, and has no industry experience whatsoever. Every thing he has ever put out is drivel. The guy is probably the biggest joke in financial "media." Rant over.

Itch's picture

If only he had of finished his article with the phrase "its my opinion that they're not", rather than trying to sound like an authority on the matter. Always give yourself wiggle room Felix, then you wont sound like a muppet.

Miles Kendig's picture

Intoxicated on the hopium that the industry they serve actually functions as advertised.  A premise a worthy contrarian would dispose of before shopping for ingredients with which to make their chilli.