Fixing LIBOR

The recent scandal with Barclays (which, rumours suggest, may soon spread) rigging their LIBOR submissions to enrich themselves and mislead investors, according to the FSA, has exposed some rather strange features of the system.

By far the biggest use of LIBOR is to set the value of EuroDollar (US dollars held outside the US) futures traded on CME. Each of these ED futures contracts represent the interest on a notional $1m loan for three months, and over 1.5m such contracts are traded every day - $400 trillion of notional lending per year.

The settlement price of a ED future is determined from the LIBOR fixing on the second business day before the third Wednesday of the delivery month, which means that they are equal to LIBOR at settlement, and very close (and converging) before that.

So why fix ED prices on LIBOR rather than the other way around?

Here we have an extremely liquid market, of synthetic loans with zero counterparty risk, which is arguably the definitive price of borrowing money. Why are we not using the well-honed pricing mechanism of that market?

During the financial crisis, Barclays reduced its LIBOR submissions from the actual rate at which it was borrowing (paras 12-14, 102-145 in the FSA report) to avoid media speculation about its financial position. On the other hand, the ED futures market is independent of the creditworthiness of the LIBOR submitters as the loans are never disbursed, only the interest which would be paid if they were, so this source of stress is simply not present. In a credit crunch, lenders (ED buyers) will back off, forcing sellers (borrowers) to lower prices (increase rates, and pay more interest), but not in a way related to the creditworthiness of a particular counterparty, only to the market in general.

Is this not exactly what we want to see in a published interest rate figure?

The ED futures price is determined by a liquid market, independent of the creditworthiness of any particular bank, and provides a yield curve in quarterly increments out to 10 years. Surely this is what we should be using instead of having a small panel of bank representatives "exercise their subjective judgement" to determine "rates at which money may be available in the interbank market" (FSA report, para 30)?

The market is already there, we're just not using it for historical reasons. This scandal has shown that, as ever and always, concentrating power in the hands of a few individuals leads inexorably to corruption. Let the sunlight in, and determine LIBOR from EuroDollar futures prices - not the other way around.

- KoW

And besides, the wench is dead

The SFO case against BAES has been praised by the former Attorney General, Lord Goldsmith. "The Serious Fraud Office intends to prosecute BAE unless it pays a fine." according to the BBC, and the story was leaked to the press on Thursday morning.

The allegations are certainly serious, but this whole affair stinks. "Give us a billion pounds or we prosecute"... targetted leaks to embarass the company and harm its share price (the worst performer in the FTSE 100 for most of Thursday, down 5% just after opening)... how is this any better than the man claimed to have been blackmailing Letterman?

Surely, if you have a good case that someone has done wrong, you prosecute them? Maybe allow them to admit guilt after being charged and get a lesser punishment for saving the effort of a trial... but to start out with dirty-tricks negotiation of what the plea-bargain will be seems... wrong.

It also suggests that maybe the SFO's case is nowhere near as strong as they'd like, and so they have to rely on anti-arms-trade sentiments and public embarassment as they can't prove it in court.

Thinking along those lines, why might that be? Well, the BBC Today programme claims that the prosecution is to be under the Prevention of Corruption (Amendment) Act, 2001. Slight problem there, in that said Act is an Irish law! No doubt they mean Part 12 of the Anti-terrorism, Crime and Security Act, 2001 - the same law they'd previously accused BAES under. Yes, that's right, the same people accusing the same company again, but for a different incident - shades of the "we'll keep prosecuting until we get a conviction" attitude over Saddam Hussein's trial?

Let's look at some facts.

The Act in question received royal assent and came into force on 14 December 2001, in the wake of 9/11. The Tanzania deal was made in 2001 (before October, when the ICAO commented on it), the South African one in 1999. I'm told that the Romanians investigated the allegations and found no evidence of criminal activity. No idea about the Czechs, but that's starting to look awfully thin: someone may have done something that was legal at the time but would now be illegal, therefore they should pay us a billion pounds for having not broken the law in the past? Or is the law retroactive - despite there being no hint in the wording and a strong tradition against ex post facto laws?

Then there's an issue of jurisdiction. Nobody is suggesting that bribes were paid in the UK, and if bribes are legal (as is the case for much of the world) where they were paid, what business is that of the SFO? The UAE has extremely strict policies on drug-taking - is it reasonable for them to prosecute people in Brighton and Amsterdam? Should US citizens drinking beer at 18 in the UK be locked-up for underage drinking when they return home (sober) to a 21 drinking-age? It seems to be a somewhat idiotic form of cultural imperialism, yet ironically it's widely supported by soi disant liberals and left-wingers - presumably because of a personal distaste for the military-industrial complex.

Even if the law is valid and applies in these cases, how strong is the evidence? Arms deals are notoriously shady, and usually involve government help on one or both sides. Is the SFO really expecting to get testimony from Saudi princes, senior foreign government officials, and the accused themselves? The UK MOD won't even let the NAO have full and accurate figures, so it's a bit unlikely that their foreign counterparts will suddenly decide to admit to accepting bribes.

So what sort of case does the SFO have? I once heard a very wise quote from a detective sergeant: "If you can't prove it without a cough, you shouldn't try and prove it with."

- KoW