Taking Stock of Bonds

April 29, 2008

Note To BBA: Fix Libor Now -- It Needs Fixing

For many reporters observing the finance markets from the sidelines, the phrase Libor probably first came up in Michael Lewis' Liar's Poker, where it is briefly explained amid all the fun antics on Salomon's mortgage bond trading floor.
 
Until we looked at Libor recently we only -- I confess -- had a vague idea about the benchmark. Yes, it's a set of rates and it's published by the BBA. And yes, it is widely used and is derived from the cost of money for UK banks. But that's about where much of the knowledge for many finance reporters ends.
 
But what we did not know until recently is that $150 trillion worth of financial products are indexed off of these products.
 
These rates are used to price everything from corporate loans to mortgage loans. They are to the finance markets what a level is to a carpenter.
 
Libor has crept into headlines in recent weeks because of questions about disparities in the rates published by the BBA every day.
 
Several reasons are offered to explain why Libor rates may differ from actual rates banks charge each other for loans. Some market watchers say banks are trying to conceal their cost of borrowing to ward off misperceptions about their credit quality outside of financial circles. The run on Northern Rock, these observers say, is very much on the minds of many anxious UK bankers.
 
Others believe Libor is skewed by the wide range of counterparty risk among banks -- something that happened in the 1990s with yen Libor.
 
Last week, the BBA's Cecilia Anto-Awuakye responded belatedly to a request for comment for a story about Libor in IDD with an email stating that the BBA "will ensure that dollar BBA LIBOR continues to be a transparent, objective, accurate rate."
 
The same note acknowledged that "economic conditions are difficult especially in the lending and credit markets. In response the BBA has brought forward the regular review of the BBA LIBOR setting process. This review is currently underway and the BBA will report on its findings in due course."
 
We hope the BBA completes its review soon. If there is something to be fixed in the way the bank rates are collected the BBA should explain how it has changed its process and why. If nothing needs to be changed in how the BBA collects its rates, then the group ought to say so and explain to the broader markets the reasons behind the disparity in rates.
 
In these uncertain times, everyone -- from lenders to investors to borrowers -- needs to know that the tools they use are accurate. 
 
As with a level, they need to know things are plumb and perpendicular. If your level is inaccurate, the farther you get from your starting point the greater the degree of inaccuracy, as my Uncle B., a civil engineer, tells me.
 
The same applies to finance.