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High & Low Finance: Steering a Better Course Past the Fiction of Libor

April 4, 2013 by Leave a Comment

Libor, if you have not been paying attention, is the London interbank offered rate — or rates, since there are dozens of them. For decades, it has been the dominant determinant of floating interest rates, with trillions of dollars in loans and derivatives priced off those rates.

Now it is ridiculous. It purports to be the rate at which banks can borrow, without collateral, from each other. Every day banks submit the rates at which they could borrow money, on an unsecured basis, in various currencies and varying maturities. Those rates are averaged, after the highest and lowest ones are eliminated, and that becomes that day’s Libor rate.

These days there is a problem: banks almost never borrow from each other, particularly at longer maturities. So the rates are fictitious — or at least not based on any information that could be verified.

Before, during and after the credit crisis, the rates were being manipulated by bankers, often with the approval of top management. Sometimes the motive was to make the bank look better — what does it say about a bank if its peers evidently will not lend money to it at the same rate they will lend to others? — but other times the motive was just to rig markets so traders could make money. It was sort of like betting on a soccer match: profits are much more likely if you fix the match before you place your bet.

Three major banks — Barclays, UBS and the Royal Bank of Scotland — were fined a total of $2.5 billion by authorities in Britain and the United States. It appeared to be a case of international regulatory cooperation at its best.

But now that cooperation is breaking down. In the United States, Gary Gensler, the chairman of the Commodity Futures Trading Commission and the man whose determination to do something helped to expose criminal behavior that evidently did not seem all that outrageous to some others, is pushing to get rid of Libor entirely. He argues that it no longer really exists, assuming it ever did, and wants to find a new benchmark for floating interest rate contracts.

But Britain and the European Commission appear to be determined to save Libor, whether or not it really means what it is supposed to mean. This week new governance rules took effect in Britain, and the European Commission is moving in the same direction. The new rules call for better governance, with efforts made to assure there is no cheating by traders.

Some banks, understandably, would just as soon get out of a business that has sullied reputations and cost billions. Some have tried to resign from the panels that determine Libor and its cousin, Euribor, a similar but less widely used system of base rates. But both European and British regulators view the existence of the benchmarks as critical and have warned banks not to leave.

“Interbank interest rate benchmarks are of systemic importance,” said Michel Barnier, the European commissioner in charge of markets. He said European legislation would force banks to submit rates.

To Mr. Gensler, the American regulator, the Europeans are moving in the wrong direction. “We have seen a significant amount of publicly available market data that raises questions about the integrity of Libor today,” he said in a speech last month. He said that there was very little unsecured interbank trading going on, and that even when other interest rates fluctuated widely — rates that include credit-default swaps on the very same banks — each bank tended to submit the same rates day after day.

He noted that a task force of the International Organization of Securities Commissions recommended earlier this year that “a benchmark should as a matter of priority be anchored by observable transactions entered into at arm’s length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values,” adding, “I agree with this.”

To put it mildly, there is no reason to think the interbank lending market fits that bill now, and there are reasons to think it will be even less true in the future. Mr. Gensler said some banks believed the new Basel capital rules regarding liquidity would make it prohibitively expensive for one bank to lend to another for more than 30 days at a time. If so, there will be no such lending.

Mr. Gensler would like to develop an alternative and points to two options. One would essentially be dependent on the Federal Reserve’s setting of the federal funds rate — the rate at which it will lend to banks. The other would be based on rates charged on secured loans. In each case these are real markets, at least in dollar-based transactions. He would like to phase in one of them as a replacement for Libor.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/04/05/business/steering-a-better-course-past-the-fiction-of-libor.html?partner=rss&emc=rss

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News Analysis: As the Bailouts Continue in Europe, So Does the Flouting of Rules

November 29, 2012 by Leave a Comment

BAILOUTS beget more bailouts.

That is the cautionary lesson from the latest revamping of Greece’s financial rescue deal, according to some economists. And they warn that unless Europe starts enforcing its own rules against bailouts and big budget deficits, governments will never get serious about putting their financial houses in order.

Of course, none of the finance ministers who worked out the new financial terms for Greece in Brussels called it a bailout. But for critics it was precisely that. By reducing interest rates and extending the payback maturities on the 168 billion euros ($217 billion) that European governments have lent Greece so far, those loans will now become barely profitable for the countries that made them.

It is the sixth bailout since the European debt crisis exploded in 2009 — three for Greece and one each for Ireland, Portugal and Spain. And these rescues have taken place despite the fact that the treaty underpinning Europe’s common currency bars bailouts by forbidding one member country from assuming the debts of another.

But if a majority of euro zone countries did not consistently flout another treaty principle — the one limiting a member government’s debt to 60 percent of gross domestic product — there would not be a euro zone debt crisis in the first place. Greece might be the most glaring violator, but Germany and France are also breaking that rule.

Although it buys time for Greece, the latest debt deal has been widely criticized as being overly optimistic in expecting Greece to produce the growth and fiscal discipline needed to bring its debt down to less than 120 percent of gross domestic product after 2020, from 175 percent today.

Skeptics also point to Germany’s demand that Greece impose another round of spending cuts in return for this latest dispensation as further proof that the architects of monetary union have decided that the last, best hope for the euro’s survival is to continue subscribing to the principle that punishments and threats from Brussels will keep spendthrift nations from falling into hock.

But some economists contend that as long as countries in trouble continue to think that they will be bailed out when they run out of money, there will be scant incentive for them to accede to the demands of the euro zone’s stability and growth pact, which requires countries to keep their debts and deficits at reasonable levels.

“There is an acknowledgment in Brussels and Berlin that the stability pact has not worked because it was not strong enough — so now they have tried to make it tougher by imposing more punishments,” said Charles Wyplosz, an international economist at the Graduate Institute in Geneva who contends that the latest Greek debt deal is nothing more than another bailout. “But what they don’t realize is that this will not work as long as local Parliaments remain sovereign.”

In a recent paper, Mr. Wyplosz argues that the only way sovereign states will become fiscally responsible over the long run is by truly grasping that Brussels will abide by the founding treaty’s prohibition against countries bailing out one another.

He points to the United States as an example.

With dozens of states that manage their own fiscal affairs, yet operate comfortably within a federal system, the common currency system in the United States has long been seen as a model by those who seek improvements in euro zone policy.

At the root of this success, say proponents of the United States model, is the fact that Washington has not had to rescue a penniless state in the last 150 years despite no law or constitutional provision against a federal bailout.

The last time a state went bankrupt was in 1933, when Arkansas stopped paying investors who held its highway bonds.

The economist C. Randall Henning, an expert on the topic, has described in detail that, in the early years of the United States, the federal government presided over numerous bailouts, until Congress stopped it in the mid-1840s.

For better or worse, American states got the message, and a majority of them have adopted various legal statutes that require them to balance their budgets each year.

Article source: http://www.nytimes.com/2012/11/29/business/global/a-bailout-by-any-other-name.html?partner=rss&emc=rss

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Fed Moves to Push Down Long-Term Rates

September 21, 2011 by Leave a Comment

In extending its campaign of novel efforts to shake the economy from its torpor, the Fed said that it was responding to evidence that there was a clear need for help.

“Growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions and the unemployment rate remains elevated,” the Fed said in a statement that listed its reasons for worry about the anemic condition of the American economy. “Household spending has been increasing at only a modest pace in recent months.”

The central bank said in a statement that the program was aimed at reducing the cost of borrowing for businesses and consumers, including the cost of mortgage loans. It hopes that the lower rates will encourage companies to build new factories and hire more workers, and consumers to start spending again on homes and cars and clothes and vacations.

Specifically, the Fed said that by June 2012 it would sell $400 billion in Treasury securities with remaining maturities of less than three years and purchase roughly the same amount of securities with maturities longer than six years. It said the result would move the average maturity of the bonds it holds to about 100 months from 75 months.

In the bond market Wednesday, the yield on 10-year Treasury notes did indeed fall after the announcement, to 1.88 percent from 1.94 percent, while the 30-year bond yield dropped to 3.02 percent from 3.20 percent. Stocks on Wall Street were down about 1.7 percent in afternoon trading.

Separately, the Fed said it would resume direct efforts to help the mortgage market by reinvesting the proceeds of its existing investments in mortgage-backed securities into new mortgage-backed securities, rather than putting the money in Treasuries.

Three members of the Fed’s 10-member policy-making committee dissented from the decision: Richard Fisher, president of the Federal Reserve Bank of Dallas; Charles Plosser, president of the Federal Reserve Bank of Philadelphia; and Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. The members were the same who opposed the Fed plan announced in August to hold short-term interest rates near zero until at least 2013.

The new effort is an experiment without a direct precedent, although the Fed tried something similar in the 1960s. Essentially, by shifting its money into riskier investments, the Fed hopes to drive down rates without expanding the size of its portfolio, as it has done twice in recent years. By reducing the supply of long-term Treasuries, the Fed intends to force investors to accept lower rates of return on a wide range of riskier investments.

Economists project that the effort could reduce interest rates by a few tenths of a percentage point, a significant increment when multiplied by the vast extent of borrowing. The forecasting firm Macroeconomic Advisers estimated in advance of the Fed’s announcement — based on its best guess about the details of such a program — that the Fed’s efforts could add about 0.4 percentage points to economic output and create about 350,000 jobs.

The Fed already is engaged in an enormous effort to stimulate growth. The central bank has held short-term interest rates near zero since December 2008. To further reduce long-term rates, it has amassed more than $2 trillion in government debt and mortgage-backed securities. And the Fed announced after the most recent meeting of its policy-making committee in August that it intended to hold short-term interest rates near zero until at least the middle of 2013.

The Fed had previously said only that it would maintain rates near zero for an “extended period,” and a new study by the Federal Reserve Bank of Cleveland found that the change in language had a significant impact. Specifically, by convincing investors that short-term rates would remain low, the Fed succeeded in lowering long-term rates — which are based in large part on expectations about the level of short-term rates throughout the longer period. Rates on the benchmark 10-year Treasury note, for example, declined by about 0.20 percentage points, the study found.

Article source: http://www.nytimes.com/2011/09/22/business/fed-to-shift-400-billion-in-holdings-to-spur-growth.html?partner=rss&emc=rss

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Business Briefing | International News: Moody’s Puts Spain’s Debt on Review

July 30, 2011 by Leave a Comment

LONDON — Casting a greater shadow over Spain’s economy, Moody’s Investors Service said Friday that it might cut the country’s credit rating in the coming months because of concerns about rising borrowing costs and the risk that private investors might have to bear some of the pain in any future bailouts.

Moody’s said it would consider cutting Spain’s long-term rating of Aa2 by only one level, which would still be a healthy investment grade.

The euro fell along with Spanish bond prices after the announcement, which comes as European leaders are trying to limit the prospect of the sovereign debt crisis, which has already ensnared Greece, Ireland and Portugal, from spreading to much bigger countries like Italy and Spain, both of which are struggling with weak economies.

Spanish and Italian bonds recovered slightly after a second European bailout for Greece was announced last week, but have dropped again this week as investors fret over whether the package will be sufficient and how long it will take to implement.

In its statement Friday, Moody’s wrote that the latest package could put additional burden on owners of Spanish debt because of the precedent set regarding the role of private bondholders.

As part of that bailout, banks and other private investors are to contribute about $72 billion by swapping their existing debt for new bonds with later maturities.

“Funding costs have been rising for some time for the Spanish government and for many closely related debt issuers, such as domestic banks and regional governments,” Moody’s said. “Pressures are likely to increase still further following the announcement of the official package for Greece, which has signaled a clear shift in risk for bondholders of countries with high debt burdens or large budget deficits.”

Moody’s on Wednesday cut the rating for Cyprus and Standard Poor’s reduce its rating for Greece, already in junk territory, by another two notches to CC, saying Greece might still default on its debt.

Moody’s said on Friday that it would weigh any risks to Spain’s debt rating against its relatively low public debt ratio compared to other European Union nations, such as Greece. It also praised the central government for meeting its 2010 target for reducing its budget deficit and the implementation of economic and social measures, including recapitlizating the banking sector.

But, it said, “challenges to long-term budget balance remain due to Spain’s subdued economic growth and fiscal slippage within parts of its regional and local government sector.”

It noted “positive signs” from the export sector but said domestic demand continued to be weak, in part due to the high unemployment rate.

The National Statistics Institute in Madrid reported Friday that the jobless rate fell in the second quarter to 20.9 percent, down from 21.3 percent in the previous quarter, but still the highest in the European Union.

Prime Minister José Luis Rodríguez Zapatero has cut wages and froze state pensions to reduce the government debt, but Spain’s financing costs surged again when European leaders failed to immediately agree on a bailout for Greece earlier this month.

Finance Minister Elena Salgado, speaking on Spanish radio Onda Cero, called on her E.U. partners to implement the decisions made last week in Brussels “more quickly” to reassure markets, Bloomberg News reported.

“Spain is on the right path for fiscal consolidation,” she said, while also noting that “Moody’s won’t take action” for another three months.

Article source: http://www.nytimes.com/2011/07/30/business/global/european-sovereign-debt-crisis.html?partner=rss&emc=rss

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Italy Bond Sale Succeeds, Despite Market Concerns

July 14, 2011 by Leave a Comment

LONDON — Italy managed to sell five-year bonds in an auction on Thursday, but yields were at their highest level in three years — a sign that some investors remain nervous about the risk of the sovereign debt crisis spreading from Europe’s vulnerable periphery to its core economies.

The sale came just before an informal meeting in Rome by officials from the European Central Bank, the European Commission and private lenders to discuss a second Greek rescue plan that leaders hope to announce next week.

Investor worries about the deadlock among European leaders over a solution for the Greek debt crisis have pushed up borrowing costs in recent days for the much bigger European economies of Italy and Spain.

Earlier doubts about whether the Italian prime minister, Silvio Berlusconi, and his finance minister, Giulio Tremonti, would agree on new austerity measures compounded the uncertainty. The Italian Senate on Thursday approved a €70 billion, or $99 billion, austerity plan; the lower house of Parliament is scheduled to vote on Friday.

The Italian Treasury said it had priced €1.25 billion of five-year bonds, the maximum it had earmarked for the sale, with a gross yield of 4.93 percent, up from 3.9 percent at a previous auction in June. It also sold a combined €3.7 billion of bonds with maturities of up to 15 years.

With Italy able to place the bonds, albeit at a higher cost, some analysts said the focus was shifting back to whether European policy makers would be able to agree on a Greek bailout.

“The Italians got away with what they intended to do and it did initially help to stabilize the markets,” said Eric Wand, a fixed-income strategist at Lloyds Bank Corporate Markets in London. “But the situation now is reverting back to European politics — and as politicians don’t seem to be in a desperate rush to get something out, the markets is starting to really get nervous.”

That message was echoed by the International Monetary Fund, whose mission chief in Ireland, Ajai Chopra, said European leaders needed to act decisively to handle the crisis.

“What is critical now is for Europe to dispel the uncertainty of what is perceived by the markets as an insufficient response,” he said at a news conference in Dublin.

Ireland, whose credit rating was recently lowered to junk status, received a positive report from the I.M.F., the European Commission and the European Central Bank.

“What we need and what is lacking so far,” Mr. Chopra said, “is a European solution to a European problem.”

Mr. Chopra called for a speedy end to the debate that has held up the construction of the new package: the extent to which private investors will have to make sacrifices as part of the new bailout of Greece.

With the E.C.B resisting any solution that involves a selective default, but the German government pressing for private investors to share the pain, policy-makers have been unable to construct a second bailout for Greece.

“We need to come to closure on this debate,” Mr. Chopra said, adding that it would be important to avoid the impression that any solution to the Greek case that involved private investors would be the template for other rescue packages.

The Institute of International Finance, which represents financial services companies, said Charles Dallara, its managing director, arrived in Rome on Thursday for discussions with Vittorio Grilli, an Italian Treasury official who is also the chairman of a high-level European committee on economic policy.

An Italian Treasury official, speaking on the customary condition of anonymity, said that the meeting would focus on the involvement of private investors, like banks and insurance companies, in a new Greek package and would give officials the chance to exchange opinions. No statement was expected after the meeting, the official said.

Article source: http://www.nytimes.com/2011/07/15/business/global/italy-borrowing-costs-hit-3-year-high-in-bond-sale.html?partner=rss&emc=rss

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