Liborgate: Detailed Analysis of 2005-2008 Rates for Big Banks

Liborgate: Detailed Analysis of 2005-2008 Rates for Big Banks

downloaded the data for LIBOR over the period 2005-2008, and decided to run regressions of the 3-month rates submitted from each bank versus 3-month LIBOR, since I think it is the most commonly used.  Here are the results:

Note the inverse relationship between the willingness to be above the consensus, and the willingness to move with the consensus.

Those that were above the LIBOR rate were in general less willing to adjust to changes in LIBOR whereas those below were more willing to adjust.  This could all be an artifact of being in a declining interest rate environment.

Also note that JPMorgan Chase & Co. (NYSE:JPM) was below the LIBOR consensus by more than Barclays PLC (NYSE:BCS) was above it.  Why is JPMorgan Chase & Co. (NYSE:JPM) escaping criticism if Barclays is getting it?

Let’s look at the residuals from the regressions over the whole period:

As you can see, we had the great moderation in effect from 2005 through mid-2007. Everything was placid; central banking could not err, even as it erred by providing too much liquidity.  Financial companies could not err either.

There are three periods here: the great moderation, the SIV/correlation crisis in the third quarter of 2007, and the bank solvency crisis in the second half of 2008.  Let’s look at them closer up.

SIV/Correlation crisis, residual bank yields in percent:

Now, in the above graph which covers July 2007 vs 2008, same graph as above, just expanded for better viewing, you can see at the left the orderliness of the past.  Deviations from normal LIBOR behavior are 1-2 basis points; the banks in the middle generally agree about where LIBOR should be on any given day, and those that are in the tails are excluded from the calculation.

But the deviations are small, relatively speaking from what the banks commonly did — +/- 0.05% usually, and almost never higher than +/- 0.10%.  You can note that in 2008 JPM and Barclays get closer together.  JPM is ~5 basis points higher than its normal practice, and Barclays PLC (NYSE:BCS) is ~5 lower, but given that on average Barclays was 7 basis points over LIBOR, and JPM 12 bp under LIBOR, that cuts the gap in half in that era.

But now lets take a walk on the wild side:

Banking Solvency crisis, residual bank yields in percent:

In mid-September, as the failures cascade, the submissions for LIBOR lose regularity.  Some go high, like Barclays Plc (NYSE:BCS), Heritage Financial Group Inc (NASDAQ:HBOS), Credit Suisse Group AG (NYSE:CS), and BTMU Capital Corporation (BTMU).  Others go low, like WestLB, Rabobank, JP Morgan, HSBC Holdings plc (LON:HSBA) (NYSE:HBC) (HKG:0005) (EPA:HSB), Lloyds Lloyds Banking Group PLC (NYSE:LYG) (LON:LLOY) and Citigroup Inc. (NYSE:C).  Most of these don’t make it into the LIBOR calculation, because they are outliers.  Sizes of the deviations are ~10x the size of what they were during the SIV/Correlation crisis.

By mid-November, semi-normalcy turns, though JP Morgan is lower than their normal practice, and Barclays starts higher, and ends the year lower than their normal practice.

The Correlation Matrix

So, if I were hunting for a conspiracy to fix LIBOR, I would look for clusters of high positive correlations, which are dark green in the correlation matrix above.  Starting with Barclays, I get BTMU, Credit Suisse, HBOS, Norinchuckin, and Royal Bank of Scotland Group plc, maybe Deutsche Bank AG (NYSE:DB) (ETR:DBK) (FRA:DBK).  With BTMU, I get Barclays, Credit Suisse, HBOS, Norinchuckin, and RBS, maybe Deutsche.  With HBOS, I get Barclays, BTMU, Credit Suisse, but none of the rest.  By the time I am done, I have an informal group that seems to act together: Barclays, BTMU, Credit Suisse, HBOS, Norinchuckin, and RBS.

Maybe there is another cluster.  Starting with Citi, I have HSBC, JP Morgan, Lloyds, and Rabobank.  Yes, upon further inspection, that’s the second and only other cluster, which means we can ignore for now Bank of America Corp (NYSE:BAC), Deutsche Bank AG, RBC, UBS AG (NYSE:UBS), and WestLB.

Here’s my punchline: go back to my table at the top.  The first group, Barclays, BTMU, Credit Suisse, HBOS, Norinchuckin, and Royal Bank of Scotland Group plc (LON:RBS) are high LIBOR submitters (along with Deutsche, who is close to being a part of the group).  The second group, Citi, HSBC, JP Morgan, Lloyds, and Rabobank are low LIBOR submitters.  (Weaker ties may exist with Bank of America and RBC.)

My initial diagnosis is this: whether formally or informally, you have two groups of banks submitting rates for LIBOR.  One group is trying to pull LIBOR up, the other is trying to pull LIBOR down.  Statistically, if I add up their intercept terms from the first table, they both sum to 0.23%, one positive, the other negative.  Even if LIBOR were a simple average, which it is not, this is a colossal game of tug of war, with two equal teams.

As it is, LIBOR excludes the outliers, and calculates an average off of those that remain.  It’s a difficult measure to manipulate.  There may have been attempts to manipulate LIBOR, and even two groups of banks trying to pull LIBOR their own way, but successful systemic manipulation of LIBOR is unlikely in my opinion.

But if you disagree, here are the two clusters of banks, pursue their collusions:

Coalition to pull LIBOR up

  • Barclays
  • BTMU
  • Credit Suisse
  • HBOS
  • Norinchuckin
  • RBS

Coalition to pull LIBOR down

  • Citi
  • HSBC
  • JP Morgan
  • Lloyds
  • Rabobank Group

Start with Barclays and JP Morgan, they are the outliers, and if there is collusion, they are the likely leaders.

By: alephblog

About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.