By John Mauldin | Jul 28, 2012
There Is Gambling in the House? I Am Shocked... Opacity and Credit Default Swaps No Access for Spain Denver, Maine, and Carlsbad
Rick: How can you close me up? On what grounds?
Captain Renault: I'm shocked, shocked to find that gambling is going on in here!
– From the classic scene in Casablanca, made in 1942
The latest scandal du jour seems to be about what is now called LIBORgate. But is it a scandal or is it really just business as usual? And if we don’t know which it is, what does that say about how we organize the financial world, in which $300-800 trillion, give or take, is based on LIBOR? This is actually just the second verse of the old song about derivatives, which is a much larger market. Which of course is a problem that was not solved by Dodd-Frank and that has the potential to once again create true havoc with the markets, whereas LIBOR can only cost a few billion here and there. (Sarcasm intended.)
The problem is the lack of transparency. Why would banks want to reveal how much profit they are making? The last thing they want is transparency. This week I offer a different take on LIBOR, one which may annoy a few readers, but which I hope provokes some thinking about how we should organize our financial world.
Let’s quickly look at what LIBOR is. The initials stand for London InterBank Offered Rate. It is the rate that is based on what 16 banks based in London (some are US banks) tell Thomson Reuters they expect to pay for overnight loans (and other longer loans). Thomson Reuters throws out the highest four numbers and the lowest four numbers and then gives us an average of the rest. Then that averaged number becomes about 150 other “rates,” from overnight to one year and in different currencies. The key is that the number is not what the banks actually paid for loans, it’s what they expect to pay. Also, please note that the British Banking Association, on its official website, calls this a price “fixing.”
Most of the time the number is probably pretty close to real, or close enough for government work. But then, there are other times when it is at best a guess and at worst manipulated.