8 ms·

This is old news for large portions of the interest rate derivatives market, which is quickly moving towards OIS[1] rates instead, based on widely traded liquid

This is old news for large portions of the interest rate derivatives market, which is quickly moving towards OIS[1] rates instead, based on widely traded liquid instruments. Also, the implication that LIBOR is purposefully a scam is basically untrue. When LIBOR was first developed, it was an improvement on other interest rate benchmarks, and it also reflected current market conditions at the time, as banks actually did regularly make bilateral interbank (the 'IB' in LIBOR) loans to one another. There are checks built into LIBOR to discourage fraud: for example, the actual calculation discards the high and low outliers, so individual banks cannot manipulate the benchmark easily[2]. But as the interest rate market continued developing, much of the actual lending transaction volume moved towards other markets; the financial crisis just accelerated that trend. So now we have a lot of contracts written against a benchmark that slowly stopped reflecting an actual interest rate market. The right path forward would probably be to renegotiate these contracts so that going foward, they're against OIS instead. [1] https://en.wikipedia.org/wiki/Overnight_indexed_swap https://en.wikipedia.org/wiki/Overnight_indexed_swap [2] https://en.wikipedia.org/wiki/Libor#Calculation https://en.wikipedia.org/wiki/Libor#Calculation

chinathrow 9y ago
> There are checks built into LIBOR to discourage fraud https://en.wikipedia.org/wiki/Libor_scandal https://en.wikipedia.org/wiki/Libor_scandal
- jwfxpr 9y ago
  'Discourage', obviously, is distinct from 'prevent'. But those checks were enhanced in the wake of the scandal, and it is based in large part on the strength of those enhanced checks that this conclusion about the underpinning validity of LIBOR has been drawn. We can all agree, though, that the next iteration could do more to stop manipulation and fraud.
cm2187 9y ago
Also most banks got badly burned with fines after the Libor scandal and introduced a pretty strict process to ensure that doesn't happen again. The "fantasy" the article is referring to is the fact that large banks have to submit a number for every currency and every tenor every day, even if they didn't fund in that currency and that tenor that day. They will usually interpolate based on other tenors. However this is only a problem for the lesser used tenors (like 2m, 8m), the most referenced tenors in private contracts (1m, 3m, 6m) tend to trade very frequently.
- JumpCrisscross 9y ago
  The most substantial change was reducing the number of currencies and tenors Libor is quoted in. Gone are the Australian dollar, Canadian dollar, New Zealand dollar, Danish krone, Swedish krona, 2 week, 4 month, 5 month, 7 month, 8 month, 9 month, 10 month and 11 month Libors [1]. That's an 80% reduction in the number of currency-tenors Libor is quoted in. [1] https://en.wikipedia.org/wiki/Libor#Currency https://en.wikipedia.org/wiki/Libor#Currency
  - cm2187 9y ago
    I wasn't aware they had been dropped. Thanks!
eightysixfour 9y ago
That's what the article stated - that at one point it made sense but banks found cheaper ways to get capital and slowly stopped lending to each other as much.
JumpCrisscross 9y ago
> they're against OIS instead OIS stands for overnight indexed swap [1]. Like the fed funds rate [2], it's only quoted for one tenor: overnight. In the United States we're somewhat spoiled with having a deep, reliable, market-based yield curve calculated every business day: the Treasury yield curve [3]. But if you want to approximate the cost of a bank borrowing for a given term on the wholesale unsecured market, Libor is still the default reference. [1] https://en.wikipedia.org/wiki/Overnight_indexed_swap https://en.wikipedia.org/wiki/Overnight_indexed_swap [2] https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate [3] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield https://www.treasury.gov/resource-center/data-chart-center/i...
- smallnamespace 9y ago
  > Like the fed funds rate [2], it's only quoted for one tenor: overnight. That's not quite true -- for example, 3m OIS swaps have fixings that are essentially the 3m average of FF over the period in question. In fact, this is mathematically a bit cleaner. If you construct an interest yield curve off of compounded 1m LIBOR vs. 3M LIBOR, you get rather different answers, whereas OIS yield curves constructed from different tenors are much closer. The argument for using OIS instead of Treasury yields is pretty simple: Treasuries reflect the cost of borrowing for the government and are implicitly affected by the government's creditworthiness (e.g. not raising the debt ceiling), while banks can actually borrow from the Fed at FF. While the US gov't funds at pretty close to 'risk free', in other markets the credit component would be significant. OIS is generally closer to LIBOR than a Treasury yield curve is.
  - JumpCrisscross 9y ago
    > this is mathematically a bit cleaner But also misleading. Bootstrapping requires making assumptions about term structure [1]. > OIS is generally closer to LIBOR than a Treasury yield curve is After the crisis the Libor-OIS spread was observed as an indicator of bank instability. They're close, but not the same. When they diverge, it's for reasons incredibly important to certain users of Libor. You're correct in the OIS rate being better than the Treasuries for estimating banks' borrowing costs. [1] http://www.investopedia.com/terms/t/termstructure.asp http://www.investopedia.com/terms/t/termstructure.asp
lomnakkus 9y ago
Just by your terminology, I trust that you know (at least somewhat) what you're talking about, so... is there an ELI5 for this stuff? I'm completely lost in these types of discussions. They seem absurdly complicated for (good|bad) reasons? Are we looking at another complexity bubble that's going to burst in 5-10 years... to the detriment of everyone but the "top execs" who'll be bailed out? My impression after reading "Too Big To Fail" -- which, BTW is an amazingly well-written book[1] -- is that "they" will probably get away with all this confusion and obfuscation... right? I really do want to learn at least a little bit, but it seems like such an impenetrable world of concepts, and I really do want to avoid the "news-based" or even "journalist-based" approach to learning about this subculture. (When a Dartboard fares better that your average journalist/investor-proxy, you know you have a gambling problem.) [1] Not sure how accurate it is, but it's really well-written and exciting. Unfortunately, it doesn't delve that much into the technical concepts in Finance :(, though it does mention LIBOR at least once.
- tanderson92 9y ago
  Regularly read Matt Levine's Bloomberg column and the articles he links to and you'll pick up more than you ever thought you would know about finance. It is also fun, how he explains things. Note: not a substitute for formal study of these things.
- cm2187 9y ago
  If you read the market section of the FT every day for a year, you will probably read enough articles with an introduction to all of these concepts to have a good enough understanding. But like any other profession, if you dive into the details, it can get quite complicated very quickly. There are lots of introductary books to each area of finance. For interest rates, the best book I have read is Interest Rate Swaps and Their Derivatives: A Practitioner's Guide by Amir Sadr. It's been written a few years ago and some things have moved on since but that's still an excellent, very practical, not too mathematical introduction to interest rate products.
- jpttsn 9y ago
  Good reasons, imho. The complexity is not (purely) a smoke screen thrown by conspiratorial insiders. Most of the harder tech HN articles would seem just as impenetrable to regular Bloomberg Terminal users.

chinathrow 9y ago

> There are checks built into LIBOR to discourage fraud https://en.wikipedia.org/wiki/Libor_scandal https://en.wikipedia.org/wiki/Libor_scandal

jwfxpr 9y ago
'Discourage', obviously, is distinct from 'prevent'. But those checks were enhanced in the wake of the scandal, and it is based in large part on the strength of those enhanced checks that this conclusion about the underpinning validity of LIBOR has been drawn. We can all agree, though, that the next iteration could do more to stop manipulation and fraud.

cm2187 9y ago

Also most banks got badly burned with fines after the Libor scandal and introduced a pretty strict process to ensure that doesn't happen again. The "fantasy" the article is referring to is the fact that large banks have to submit a number for every currency and every tenor every day, even if they didn't fund in that currency and that tenor that day. They will usually interpolate based on other tenors. However this is only a problem for the lesser used tenors (like 2m, 8m), the most referenced tenors in private contracts (1m, 3m, 6m) tend to trade very frequently.

JumpCrisscross 9y ago
The most substantial change was reducing the number of currencies and tenors Libor is quoted in. Gone are the Australian dollar, Canadian dollar, New Zealand dollar, Danish krone, Swedish krona, 2 week, 4 month, 5 month, 7 month, 8 month, 9 month, 10 month and 11 month Libors [1]. That's an 80% reduction in the number of currency-tenors Libor is quoted in. [1] https://en.wikipedia.org/wiki/Libor#Currency https://en.wikipedia.org/wiki/Libor#Currency
- cm2187 9y ago
  I wasn't aware they had been dropped. Thanks!

eightysixfour 9y ago

That's what the article stated - that at one point it made sense but banks found cheaper ways to get capital and slowly stopped lending to each other as much.

JumpCrisscross 9y ago

> they're against OIS instead OIS stands for overnight indexed swap [1]. Like the fed funds rate [2], it's only quoted for one tenor: overnight. In the United States we're somewhat spoiled with having a deep, reliable, market-based yield curve calculated every business day: the Treasury yield curve [3]. But if you want to approximate the cost of a bank borrowing for a given term on the wholesale unsecured market, Libor is still the default reference. [1] https://en.wikipedia.org/wiki/Overnight_indexed_swap https://en.wikipedia.org/wiki/Overnight_indexed_swap [2] https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate [3] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield https://www.treasury.gov/resource-center/data-chart-center/i...

smallnamespace 9y ago
> Like the fed funds rate [2], it's only quoted for one tenor: overnight. That's not quite true -- for example, 3m OIS swaps have fixings that are essentially the 3m average of FF over the period in question. In fact, this is mathematically a bit cleaner. If you construct an interest yield curve off of compounded 1m LIBOR vs. 3M LIBOR, you get rather different answers, whereas OIS yield curves constructed from different tenors are much closer. The argument for using OIS instead of Treasury yields is pretty simple: Treasuries reflect the cost of borrowing for the government and are implicitly affected by the government's creditworthiness (e.g. not raising the debt ceiling), while banks can actually borrow from the Fed at FF. While the US gov't funds at pretty close to 'risk free', in other markets the credit component would be significant. OIS is generally closer to LIBOR than a Treasury yield curve is.
- JumpCrisscross 9y ago
  > this is mathematically a bit cleaner But also misleading. Bootstrapping requires making assumptions about term structure [1]. > OIS is generally closer to LIBOR than a Treasury yield curve is After the crisis the Libor-OIS spread was observed as an indicator of bank instability. They're close, but not the same. When they diverge, it's for reasons incredibly important to certain users of Libor. You're correct in the OIS rate being better than the Treasuries for estimating banks' borrowing costs. [1] http://www.investopedia.com/terms/t/termstructure.asp http://www.investopedia.com/terms/t/termstructure.asp

lomnakkus 9y ago

Just by your terminology, I trust that you know (at least somewhat) what you're talking about, so... is there an ELI5 for this stuff? I'm completely lost in these types of discussions. They seem absurdly complicated for (good|bad) reasons? Are we looking at another complexity bubble that's going to burst in 5-10 years... to the detriment of everyone but the "top execs" who'll be bailed out? My impression after reading "Too Big To Fail" -- which, BTW is an amazingly well-written book[1] -- is that "they" will probably get away with all this confusion and obfuscation... right? I really do want to learn at least a little bit, but it seems like such an impenetrable world of concepts, and I really do want to avoid the "news-based" or even "journalist-based" approach to learning about this subculture. (When a Dartboard fares better that your average journalist/investor-proxy, you know you have a gambling problem.) [1] Not sure how accurate it is, but it's really well-written and exciting. Unfortunately, it doesn't delve that much into the technical concepts in Finance :(, though it does mention LIBOR at least once.

tanderson92 9y ago
Regularly read Matt Levine's Bloomberg column and the articles he links to and you'll pick up more than you ever thought you would know about finance. It is also fun, how he explains things. Note: not a substitute for formal study of these things.
cm2187 9y ago
If you read the market section of the FT every day for a year, you will probably read enough articles with an introduction to all of these concepts to have a good enough understanding. But like any other profession, if you dive into the details, it can get quite complicated very quickly. There are lots of introductary books to each area of finance. For interest rates, the best book I have read is Interest Rate Swaps and Their Derivatives: A Practitioner's Guide by Amir Sadr. It's been written a few years ago and some things have moved on since but that's still an excellent, very practical, not too mathematical introduction to interest rate products.
jpttsn 9y ago
Good reasons, imho. The complexity is not (purely) a smoke screen thrown by conspiratorial insiders. Most of the harder tech HN articles would seem just as impenetrable to regular Bloomberg Terminal users.