Saturday, 30 June 2012

Libor Fixing

Barclays has been fined heavily by regulators in the USA and the UK for manipulating Libor fixings, and other banks are under investigation.  I've read a fair bit about how shocking the disclosures have been: I'll seek to clarify here what is and what isn't a surprise.

Libor stands for the London Interbank Offered Rate.  It is supposed to be "The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11.00am London time".  It's produced by the BBA (British Bankers' Association) for ten major currencies with fifteen maturities in each, from overnight to one year. It's calculated every business day by asking each member of a panel of banks what rate it could borrow at, eliminating the upper and lower quartiles, and averaging the others.  There are currently 18 members of the largest panel (for US dollar rates) and six for the two smallest (for Swedish Krona and Danish Krone), so a bad quote from one member of the panel will have a small but not zero effect on the calculated rate unless both the bad and the true quote fall in the same extreme quartile.

Bob Diamond, the Barclays Chief Executive, who seems to have been relaxing with his money while the wrongs were being done, has written to the chairman of the House of Commons Treasury Select Committee to explain in outline what happened.  There were two sorts of manipulation: the first went on between 2005 or earlier (the investigation goes back to 2005) and 2008, and involved Barclays' submissions to the BBA being adjusted to suit the position of the trading book - if the book was a net payer of a particular rate, Barclays would submit a low quote, and vice versa.  This is truly shocking, the more so in that the traders involved seemed to have been utterly brazen in the emails they sent about it - there seems to have been no sense that they were doing anything improper.  Diamond's excuse is that only relatively junior traders were involved in this abuse, but it's elementary that the BBA submission process should have been entirely isolated from trading considerations, and it's a management failing that this was not the case.

The second manipulation occurred during the banking crisis between 2007 and 2009, when Barclays submitted artificially low quotes in order not to stand out as a poor credit risk.  Diamond's excuse is that they did it because the other banks were doing it and they would have looked bad by comparison if they hadn't.

Whatever the truth of the excuse, no one who's been paying attention, and certainly not the British Chancellor of the Exchequer, should be surprised to learn that banks were quoting artificially low rates.  The Wall Street Journal published reports to that effect in April and May 2008, following a cautious investigation by the Bank for International Settlements (pp59-72 here) which found "Little evidence of manipulation".
The clearest evidence that Libor rates have been unrealistic comes from cross-currency basis swap spreads.  These swaps allow one to synthesize a floating-rate loan in one currency from a floating-rate loan in another currency.  If banks could borrow freely at Libor in both currencies, the spreads would be close to zero.  But here's a chart I created in 2009 for a conference presentation that touched on the subject:

The red line is the cost of borrowing in Euros at the Euribor rate - a rate similar to Libor but calculated by the European Banking Federation.  The green line is the cost of borrowing in dollars and using a basis swap to convert the loan into euros.  The separation between the two lines, which appears in August 2007 and spikes in November 2008 tells us that one or both of the rates is wrong - in fact it's the dollar rate which is artificially low.  If banks could really have borrowed at dollar Libor they would have done that in preference to borrowing at Euribor, but they couldn't.  It may be relevant that the Euribor panel is asked a slightly different question - what rate do they think one bank could borrow from another at, rather than what rate could they themselves borrow at.  So it is less embarrassing for them to quote a relatively high rate.

Who has been damaged by all this?  Diamond claims about the first manipulation that "The interventions in question were typically on the short term one and three month rates relevant to the wholesale markets and not the longer term rates used to set, for example, retail mortgages". I suspect that's inaccurate. Only a small proportion of mortgages use Libor contractually to set their rates, but my brief investigation suggests that in the UK the ones there are mostly use three-month Libor.  All the same, my guess is that most mortgage holders will have profited overall from the manipulations, since they kept rates artificially low during the banking crisis.  On the other side, any institution which was issuing Libor-based mortgages during 2008 should have been aware of the problems with the numbers and ought to have widened their spreads to compensate.  Thus the people with a genuine grievance ought for the most part to be the Barclays' market counterparties who lost out when the fixings were manipulated to suit Barclays' trading book.  I don't know how eager they'll be to sue, but I'm sure there will be plenty of lawyers with the whiff of money in their nostrils to encourage anyone with any sort of a claim to have a go.

Update: I recommend this post by Frances Coppola, which includes quotes from the FSA report setting out exactly what Barclays was up to.

Wednesday, 13 June 2012

Poll Dance

Spot the connexion between these two news headlines:
The people don’t want a referendum on Europe, insists No 10
Yes, that's right, they're both reporting on the same opinion poll.

The trick is in the question.  Respondents were asked "Which of the following statements comes closest to your view?", with the options:
  • No need for a referendum in the foreseeable future
  • There should be a referendum, but now is not the time
  • There should be a referendum now
Of 2006 respondents, 379 (18.9%) chose "no need", 626 (31.2%) chose "yes but not now", and 1001 (49.9%) chose "yes, now".

So a Downing Street spokeswoman could say without lying "The British people do not want a referendum on the European Union at the moment", because most respondents (by a majority of 0.2%) don't want a referendum now.  The Telegraph headline drops the qualification "at the moment" because headline writers like to keep things snappy.  And the Express could say honestly enough by their standards "A new poll showed more than 80 per cent of voters are crying out for a referendum", because indeed the poll shows that 81.1% of respondents think there should be a referendum.  "Demand" and "Crying out" are wild exaggerations, but it's the Express; readers expect nothing less.  Note that the "Now" in the headline refers to the time of the opinion poll, not when the vote is wanted.

Opinion pollster Antony Wells remarks "Referendums are popular per se, whatever the subject asked about, people will support having a referendum on it."  To which I would add: they're much less enthusiastic about voting in the referendum itself: the turnout at the referendum on AV was 42%, compared with 65% at the last general election.

Also, there's a gap between "no need for a referendum" and "there should be a referendum".  Another option could have been included along the lines of "I might want a referendum in the future as the EU evolves, but there's no need for one as things stand".  I think that would have increased the total "no need" vote.

A fair representation of this poll would be "Half the population wants a referendum now on the EU, and only 19% is willing to rule out a referendum for the foreseeable future".  Is there any demand for fair representations?


Incidentally, this was an online opinion poll.  I don't think the method is worse than telephone or face-to-face polling.  It shouldn't be confused with online polls which are open for anyone to vote in: they're worthless.

Saturday, 2 June 2012

U-turn on Charity Tax Relief

George Osborne's budget in March announced that tax reliefs for high earners, including on donations to charity, would be capped for each taxpayer at one quarter of their income.  I commented at the time on the implausibility of the reasons they gave for the cap. On Thursday, Osborne recanted: donations to charity will not after all be included in the cap.
I can confirm that we will proceed next year with a cap on income tax reliefs for wealthy people, but we won't be capping relief for giving money to charity.
It is clear from our conversations with charities that any kind cap could damage donations, and as I said at the Budget that's not what we want at all. So we've listened.
Osborne did not in fact say anything in his budget speech about not wanting to damage donations, but he may well have made some such remark to someone "at the Budget".

What's remarkable about this is that either Osborne is more stupid than I think he is (and I am not an admirer), or he knew from the first that restricting tax relief on donations to charity would mean that charities got less money.  Osborne's colleague, Treasury Secretary David Gauke said (in a radio interview) that the charity tax relief cap would bring in £50m-£100m a year and that money has to come from somewhere.  No one knows just what the effect will be on donors' behaviour: if they make the same net donations as before, £100m saved will cost the charities £100m; if as seems likely the cap acts to discourage donations the effect on charities will be amplified (though the estimate from Oxford Economics that it would cost the charities £500m is highly unconvincing).

So what's happened is that Osborne announced his plan, and the charities who would obviously be adversely affected by it protested.  There was nothing remotely unpredictable about that.  And if Osborne wasn't willing to stand up to the protests, why did he announce the plan in the first place?

I have a suspicion that he planned this all along.  The sums involved are small enough not to make much difference to the budget, so he was always in a position to change his mind.  And by starting the fight then withdrawing from the field, Osborne leaves tax reformers on the left who support the proposal in the line of fire. And most importantly it's handy for a government to have a popular announcement up its sleeve for release when it wants to deflect adverse publicity, say when the Culture Minister is in trouble for his extraordinary closeness to News Corp (it will be recalled that he was brought in to oversee News Corp's bid for BSkyB because Vince Cable was found to be insufficiently neutral).

Hanlon's (or Heinlein's) razor advises "Never attribute to malice that which is adequately explained by stupidity."  But is Osborne really that thick?  Perhaps his supporters would like to help me on that.

Friday, 1 June 2012


I wrote in February that the Greek bailout couldn't and wouldn't work, linking to commentators who pointed out that the plan relied on unrealistic growth projections, and predicting myself that the Greek electorate would in any case vote against the plan.

Three months later, things have moved on.  The "Sustainability Report" behind the plan projected that the Greek economy would shrink by 4.3% in 2012, or by 4.8% in a downside scenario.  Now Official estimates published this month say there was a contraction of 6.2% in the first quarter alone.  There is nothing at all to make one think that's going to turn around: rather the uncertainty, and in particular the possibility of an exit from the Euro, is making things worse (why invest Euros when you may get back Drachma, or pay bills in Euros when you may be able to pay them in Drachma).  The plan is already hopelessly off course.

Also this month, the Greeks held a general election (a little later than previously promised).  The result was that PASOK and New Democracy, the two parties which had backed the austerity deal - previously the two dominant parties - lost a lot of support, PASOK especially.  (Because of the collapse of the PASOK vote ND emerged as the largest single party, which earns a 50-seat bonus, so it actually increased its number of seats.)  It proved impossible to form a government, so the electorate will vote again on 17th June.

So the bailout plan is failing, and the Greeks can't abide it anyway.  What next?  Greece seems to have been a vote against austerity, but not against the Euro.  However, there are limits to what can be decided democratically.  Absent armed intervention, a country's government can make all sorts of decisions about how to run the economy, including choosing not to pay its debts.  But it cannot decide that other countries should give or lend it money.  So if the bailout money stops flowing, Greece will run out of Euros.

Suppose that the June election results in SYRIZA being able to form a coalition government.  The likely policy of such a government would be to attempt to renegotiate the austerity plan.  The new French government might be sympathetic, but it's Merkel that decides.  Merkel would have to address the fear that if Greek banks are allowed to fail that will increase the perceived risk of failure of banks in Spain and the other PIGS, and if Greece leaves the Euro that will increase the perceived redenomination risk (i.e. the risk of having one's money in the bank converted to a new, rapidly depreciating currency).  Either way, there would be a run on the banks, in Spain especially.  This would be so bad for Germany that the Greeks might hope that Merkel is just bluffing when she insists they have to stick to the austerity plan.  However, Germany is a democracy too, and its electorate seems unsympathetic to Greece.  I expect Merkel to offer some modest measures to promote growth, but no more.

If the EU and Greece can't agree a bailout plan, can they agree a plan for Greece to leave the Euro?  I can't see them suddenly becoming decisive.  My guess (but my crystal ball is rather murky) is that there will be no formal divorce.  Instead, the Greek government will introduce a New Drachma in parallel with the Euro, with whatever legislation is needed to allow it to meet its domestic obligations in the new currency, and to make it possible for the recipients to buy stuff and pay mortgages with it - there would be an official conversion rate for these purposes, but no right to exchange Drachmae for Euros.  Legislation would follow piecemeal to address the resulting difficulties by extending its use.  And Gresham's law would operate.

Meanwhile, I have one helpful suggestion.  Greece should cut its arms imports to zero.  That's a big cut, Greece is Europe's largest arms importer, and the tenth largest globally.  Its debt would be manageable now if it hadn't spend so much on arms over the last twenty years.  And cutting arms imports would do no damage to the economy - there's no multiplier effect on such spending.  It would need to cancel existing contracts, but since the largest contracts are with Germany and France, which are anxious to see Greece balance its budget, that should present no problem.  And if Greece perceives a military threat from Turkey, the European powers can meaningfully guarantee to protect it - a free promise, since Turkey is not in fact going to start anything.

Yes, you're right, that's a hopelessly impractical suggestion.  Germany and France are strongly in favour of Greek budgetary responsibility, but not so strongly as they're in favour of their own exports.