Wednesday, October 8, 2008

The Debts of the Spenders: The LIBOR Cartel

What is the cost of money? Or, to put it another way, what is the cost of debt? There are 2 answers to this question.

1) On the private side -LIBOR is an important interbank lending rate set by the private sector. It is rougly comparable to the US Fed Funds rate.

$USD LIBOR is set by the BBA, or British Banker's Association, a cartel of commercial banks every day. While the BBA has over 200 members and scores of associates, the inner circle which determines the private cost of short term US debt is composed of only the 16 largest members.

JPM, C, and BAC sit on this panel (GS and MS may sit here too since they are now retail banks. Their real status is still up in the air). The average of the middle 8 banks quotes is the daily rate reported by Reuters.

For years, LIBOR tracked the Fed Fund rate....until this year.

Starting in January LIBOR started diverging big time.

Like any cartel, the members inevitably resorted to undercutting and hiding information from each other to gain an advantage. Chief among these problems were members hiding the true extent of their Level 3 Assets.

The reason why LIBOR is so important is because it is the benchmark used as an index for most OTC derivatives....such as the $600 or $800 Trillion in CDS.


Libor members sit on a panel that determines interest rate swaps...while also being the same counterparties to such swaps.

LIBOR "supposedly" averages the rate by taking the middle 8 and tossing out the top and bottom 4 quotes. However, there is still room for abuse ESPECIALLY when all the cartel members have been hiding Level 3 assets from each other.

2) On the government side - Coming soon.


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