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geithner to king re: libor July 13, 2012

Posted by Bradley in : financial regulation , trackback

The Bank of England published communications between Geithner and King in May 2008 with respect to ideas for changes to the BBA governance arrangements. That the then President of the Federal Reserve Bank of New York should be seeking to affect the way in which Libor is calculated is odd, given the origins of US dollar Libor as an offshore rate. US dollar Libor developed to avoid interest rate controls in the US. Of course, by 2008 Libor had become standardized and had moved back into the US as a rate of interest used in domestic US transactions, so the history wasn’t so relevant. Still, the idea of federal reserve/central bankers in the UK and US co-operating over the governance of Libor is interesting.

As to what Geithner proposed, as well as some sensible-seeming governance suggestions, for example that Bank auditors be expected to attest to the accuracy of banks’ Libor rates, and an idea of establishing random sampling of rates submitted by an expanded set of contributor banks to minimize misreporting, there are some other rather different suggestions. For example, Geithner says that more US banks should be involved in Libor fixing (and this would surely help improve the profile of these banks). He also suggests a second fixing after the US markets open because this would be more indicative of conditions while the US market was open. But Libor was supposed to reflect rates in London and not in New York. Now, it is true that whereas in the early days there were divergences between Libor and domestic US rates, over time there was a convergence. But what to make of this? To force greater convergence or not? I find the combination of these suggestions (with King’s response that the Bank of England would ask the BBA to include them in its consultation document) with the language early in the Geithner memo about enhancing “perceptions of the BBA as an objective intermediary in the rate-setting process” to be rather odd. Was the BBA to be the Fed’s poodle or an objective intermediary? Was Libor to be a rate derived from the market or one managed by central banks?

The New York Fed also released documents this morning for the forthcoming Congressional hearings into Libor. These documents raise one question which doesn’t really feature (yet) in all of the inquiries and investigations into what happened, and that is why, given that it looks as though there really wasn’t an effective interbank market frequently during the crisis, no-one seems to have thought to recognise that fact. After all, documentation for Libor-based transactions has contained language providing for what happens if there is no Libor since inception.

So now back to the Geithner memo. How can a mechanism to feed US market based rates into Libor fixing be a solution to a problem that Libor does not in fact reflect what it purports to reflect which is rates in the London interbank market? There seems to me to be a transparency issue here.

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