LIBOR for Dummies
Many have written on the LIBOR scandal over the past week, but what is LIBOR actually, and what are the implications of manipulating IT? Some insight on the subject by Peter Tchir.
The BBA provides pretty detailed analysis of the process. The key here is what the rate is meant to be. The contributors, are supposed to submit a rate for each currency they contribute for overnight, one week, two week, and monthly out to a year. The rate is meant to be:
“At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”
This is a bit like self-reporting your weight. The bank is supposed to submit a rate where they think they could borrow, not where they actually borrowed or where they would lend to other contributors. Right from the start the question raises questions that have been discussed for years.
How can a bank “know” where some other bank will lend them money? Can’t they use transactions? Can’t they get firm “offers” from other banks? Why not have the banks submit levels where they would lend to other banks?
The very nature of the question used to solicit rates tells you all you need to know. LIBOR has always had an element of “gamesmanship” if not outright lying.
In general, banks will tend to submit lower rates and attempt to artificially lower LIBOR. There are two reasons for this:
Golden Cognitive Dissonance
Guest post by Azizonomics.
Simon Jack of the BBC asks a question that many of us have already answered:
Gold v paper money: Which should we trust more?
Fortunately, this gives way to some relatively fair coverage:
Detlev Schlichter is a former banker and the author of Paper Money Collapse and he says the current system is fatally flawed.
“The problem is that what we use as money can be created and produced by the privileged money producers – which are the central bank and the banking system.They can produce as much of this money as they like. And so the supply of this form of money is entirely elastic, it is entirely flexible.”
Detlev Schlichter believes this will, ultimately, lead to people losing faith in our current system of elastic money and turning to something that does not stretch – like gold.
HFT Parasites killing the market
It has been a while since we wrote about HFT and the implications on the markets. Here are some reflections by Joe Saluzzi of Themis Trading.
Since Joe first spoke with us last year, HFT firms have only increased in size and share of market activity. Here are some staggering statistics on how influential they have become:
- HTFs make up between 50-70% of the volume seen across market exchanges today.
- 2% of the traders on many exchanges (HFTs, specifically) represent 80% of the volume.
- A single large HFT firm (referred to as a Direct Market Maker) can account for 10%+ of a market’s volume on a given day
- Large HFT firms make between $8 to $21 billion a year.
- HFT trades occur in milliseconds (i.e., a small fraction of the time it takes your eye to blink).
With such scale, speed, and profitability, HFTs have turned the market away from being an efficient price-setting mechanism and perverted it into a casino where the clientele of human investors gets fleeced.
VIX reversal signal around the corner?
Sometimes the simplest ways to analyze the VIX are the best.
The chart of the week below shows weekly bars of the S&P 500 index and the VIX going back three years. In the VIX study at the bottom, I have also highlighted in yellow the zone from 15-18, which has proven to be a fairly robust zone of support for the VIX during this period. Note that while the VIX has slipped below 15 on occasion, it has eventually bounced off of this support level in each instance and, perhaps more notably, a VIX bottom in the 15-18 range has also coincided with a top in the SPX each time around.
With the VIX in the low 17s as I type this, bulls and bears alike should be on the lookout for signs of a bottom forming in the VIX – and be prepared to position their portfolios accordingly.
Rotten Banking?
With Diamond resigning, we ask ourselves, just how rotten is banking? Bloomberg on the subject.
Why so exercised? In the Barclays settlement documents, regulators released smoking-gun e-mails that reveal the extent of the dirty dealing between bank traders (looking to protect profits and bonuses) and senior officials in bank treasury units (hoping to convince markets that their banks weren’t in financial difficulty). The two aren’t supposed to collude, but it’s obvious that the Chinese walls between them come with ladders.
Libor and its euro counterpart, the Euribor, are benchmark rates determined by bank estimates of how much it would cost them to borrow from one another, in different timeframes and currencies. The banks submit sheets of numbers every weekday morning, London time. An adjusted average of the rates determines the size of payments on mortgages and corporate loans worldwide. The rates also serve as an indicator of the health of the banking system. Because some submissions aren’t based on real trades, the potential exists for manipulation.
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