Libor scandal is whitecaps in a thimble

Commentary: Rigging workhorse rate was stupid, and the stupid should resign

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First some data, then Libor. Tempest or titillation? The effects from global markets to your adjustable-rate mortgage — earth-shaking? Or teapot-tilting?

June jobs data are as-was in May and April: 75,000 new jobs, poor, but afloat!

The June data from the Institute for Supply Management (ISM) is more concerning, the overall manufacturing index (PMI) falling to 49.7 percent from 53.5 (a reading below 50 percent indicates the manufacturing economy is generally contracting). "Internals" also crashing: new orders down 12.3 to 47.8, and prices of raw materials collapsed another 10.5 to 37 (inflation risk is zero).

For comparison, China and all of Europe are lower in the 40s, Spain below the 44 marking serious recession.

Libor — the London Inter-Bank Offered Rate, published by the British Bankers Association since 1986 — is not an independently verifiable market benchmark. It’s compiled by survey, and posted at 11 a.m. GMT each day, in maturities ranging from overnight to one year, in 10 currencies.

All floating-rate IOUs are tied to an index of some kind, the chatter on trading floors all day every day "over" — over U.S. Treasurys, British gilts, German Bunds, over Libor. Nobody knows how many trillions worth of securities are tied to Libor.

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The first U.S. adjustable-rate mortgages (ARMs) appeared in volume in 1980, most commonly tied to the Cost of Funds Index (COFI), 1-year Treasurys, or Libor, plus a spread, aka "margin."

COFI was the average cost of a deposit to a savings and loan in California, Arizona and Nevada (only). Yes, the rate you paid to an S&L was determined in part by the rates that it decided to pay its depositors. Margins ran from over 3.00 percent to below 2.00 percent. COFI loans were a Bubble casualty, finished by Lehman.

The Treasury stopped selling 1-year T-bills in 2001 because we were in budget surplus (what a thought). Before 1-year T-bills came back in 2008, the index value in your mortgage adjustment was inferred by statistical artifact — the Constant Maturity Treasury index, or CMT. Fannie margins for this most-common index have been 2.75 percent. However, the Fed at 0 percent since 2008 has pulled the 1-year down to 0.19 percent, farther than ever imagined, and T-bill-tied ARMs are scarce.

If you have a one-month, three-month, six-month, or one-year Libor ARM, you pay 2.25 percent over the equivalent Libor maturity. The 0.50 percent difference between margins over Libor and T-bills reflect the ’80s-’90s spread between bills and Libor. Not now! One-year Libor is 1.069 percent today, plus margin a "pay rate" of 3.319 versus a T-bill-tied 2.94 percent.

Every ARM promissory note contains a provision for a replacement index (un-named) if the one in the note becomes "unavailable."

Back to the tempest. Apparently between 2005 and 2010 bankers surveyed by the British Bankers Association began to fib on the low side.

To what effect — magnitude — nobody seems to know, but in an index measured to three decimal places, not much. But a hell of a lot of money moves by each one-thousandth. Some motivation to fib was ordinary cheating, but some was self-protective, not wanting to tell a panicked world how much your bank had to pay for funding.

Everyone in the market knew that Libor was somewhere between inexact and imaginary, and banker-determined. Regulators knew that the BBA survey had "irregularities"; and the financial press routinely ran stories about Libor rigging. Everybody-does-it is a poor defense, but deep inside inexact markets everybody must stick a wet finger into the wind and announce velocity.

Everybody does something else: everyone wants precision in life beyond our ability to have it. Thus we live in constant, comfortable, and fabricated illusion, and we are enraged when our self-deceptions are exposed.

To have rigged Libor was a Bad Thing. The downside rig did cause losses in some heavily structured finance — "inverse-floaters" — hurting those who tried to outsmart future interest-rate probabilities. To have rigged Libor during the greatest bank run of all time, every financial institution and the system itself facing panicked suspicion… that was a Stupid Thing. The stupid should resign forthwith.

However, relative to our current predicament and bad deeds private and public, this Libor thing is whitecaps in a thimble. A microscopic storm has morphed into yet another hysterical witch-hunt. Be damned careful. There are good witches and bad ones, and when the bad ones are loose you’ll wish you hadn’t dropped a house on your good one.


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