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.


Crooks running the prison....
"In a jail, within a gaol, within a white free protestant maelstrom..." James Douglas Morrison, a poet
you are tired, sheeple, very tired, you are drifting off to sleep...everything is beautiful, you are perfectly safe, don't worry...
There is a hoax here somewhere.
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.
I made a video to simplify the LIBOR scandal.
http://youtu.be/VO6XqbOWyJY
The question I want to know is WHY are they telling us now?
Stay ahead of the curve people.
When Caroline Hyde gets all passionate like Hermoine Granger,
I get the good tingles all over.
but, but, but....derivatives
I hate it when financial collapse is interrupted by a weekend.
I hate it when my weekend is interrupted by financial collapse.
But maybe that's just me.
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...
800 trillion has been effected by the liebor scandal. I would not call this a non event.
Its not a question of what is effected but who is effected. get on with the programme.
or event affected
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.
Felix (a cat) Salmon (a fish) .... sounds like a cover name for someone at the financial division of the NSA
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
"... competition produces quality, cartels produce propaganda."
good Post. I tweaked your last line.
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.
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.
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.
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.
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.