Monday, March 28, 2011

The Lie in LIBOR; Tip of the Iceberg

I love the furor over the London Interbank Overnight lending Rate, LIBOR. It seems one or more of the bulge bracket banks might have - gasp - lied about the rates they would offer their competitors.
I first heard of LIBOR when I started working at Telerate (later part of Dow Jones) in the early 1990's. I was on the energy desk and our reporting counterparts on the finance desk would take the LIBOR calls. The participating banks would call in, tell them their prices and the finance desk would average them and post them online for the British Bankers Association. That's it. Just taking the calls, averaging the prices - throwing out the top and bottom five - and posting them online. Then gazillions of dollars were priced using that figure. When I heard how important it was I said: "You are kidding." But no, they weren't.
Then I told them that in the oil business, gazillions of barrels of oil each day were priced using journalist's assessments of the market. They said: "You are kidding." But no, I wasn't. Then I said: "How do you know the banks don't lie about LIBOR rates? Everyone lies to Platt's about the prices." The finance desk was shocked. First, that banks would lie about their rates. And second, how could most of the world's oil supply be based on price assessments by journalists? And why would their sources lie?
When you think about it, it IS quite shocking that over 90% of global oil production - around 87 million barrels per day - is priced using subjective assessments. So Platt's moved to try and get away from the journalist's powerful input a few years ago by inventing something they call The Window. The Window is a Yahoo (or Reuters) instant messaging tool whereby buyers and sellers of oil enter their bids, offers and selling prices. Then the journalists take averages of these prices for each product or crude oil type and publish them. Despite all assurances, the oil traders do lie about what they would pay or offer or what they have done. It is, in fact, easier for them to lie using The Window than it was talking to journalists who made the assessments subjectively.
Why they lie is not difficult to understand. If you are loading a cargo in, say, Russia you would like to get it at the lowest price possible - then you can sell it at a profit. So you tell Platt's that the market is crap by lying on The Window. Then all of your buddies who are also loading will support you with their lies. The traders that have sold oil to end users that is being delivered at that time understandably want the oil to be priced higher. So they lie to The Window to try and get prices up. Therefore, it probably averages out in the end.
And so, probably, does LIBOR. If one bank wants to be able to borrow money cheaply, it will report lower interest rates. It seems likely that there will be another bank out there that wants to lend at higher rates, so it reports higher rates. See? Quits. So people can stop freaking out that financial markets participants lie. It is part and parcel of the markets.

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