Libor and Euribor in various acts

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To the bad news in international markets: crisis in the eurozone, losses in J. P. Morgan of around US$5,8 billion and investigations on money laundering in HSBC, among other delicatessen, it has recently been added, as a new set to the current circus, the scandal associated to the manipulation made to the LIBOR (and, as result, to the EURIBOR too) during the worst part of the 2008 crisis. As we all know, that rate is the reference for millions of financial transactions in the world, such as deposits, loans, derivatives, etc. I think that there are two different approaches to this subject.

The Libor is a rate formed everyday based on a question initially made to about 16 global banks: How much would it cost you to borrow,in relation to your peers, in 10 different currencies and in 15 different periods (from one day up to 12 months)? Then, the highest four and the lowest four rates are discarded. That is fine, but the fact is that last week, it was known that the Barclays Bank (the third largest bank in England), in an extrajudicial agreement, accepted having manipulated the Libor, for which action it will have to pay a penaltyof about US$ 450 million to both American and British regulators.

What had happened? What Barclays did in the midst of the 2008 financial crises, was to underestimate the rate it reported, with the purpose of looking more solvent than it actually was and thus trying to avoid the punishment of the markets during that period. As I said before, this event can be visualized in two different levels. The first one, closer to the criminal level, is related to the way in which this happened, in order to get effective results.The behavior of Barclays bank could not be considered as an isolated one and therefore, as it was suspected, the Financial Times published in front page last week that there couldbe at least 12 global blanks implicated in this affair. Altogether, these banks would face penalties of about US$ 22 billion for violating the rules and for damages caused to investors and related institutions, according to a study made by Morgan Stanley.

To add more ingredients appropriate for a novel written by Agatha Christie, it comes out now that another person involved in this affair is Paul Tucker, the former Deputy Governor of the bank of England, who just resigned after this scandal surfaced. It seems that he knew about this irregular situation, since he had sent a message to Barclays Bank commenting on how high it seemed to him the rate that the bank was reporting. In addition, the CEO of Barclays Bank, Bob Diamond also resigned to his post (indicating that he would forgo a personal compensation of US$ 30 million) and it all seems that the investigation is being extended to more institutions. But there is another side of the story which is worth to talk about.

In calculating said referential interest rates, the costs of borrowing money reported by the banks are the expected ones, not the real rates. In this context, observing what is happening with financial markets in the eurozone and the Euribor now, and considering all the uncertainties that existed in 2008 and that still exists nowadays, do we know if loans between banks are fluid and recurrent? Were there so during the 2008 crises and continue like them now? Instead, in a decision of “flight to quality”, looking for safety, it seems that they rather preferred and still prefer to maintain their funds in papers of the European Central Bank, obtaining zero percent nominal interest rates or negative rates in real terms, not risking to lend money to their peers, whose apparent healthy condition could just be a Hollywood style movie montage.In the case of Euribor, there is also a small but big detail that complicates it as a referential rate. In a different way than the Libor, the banks that report information for Euribor are not asked how much they think would have to pay to borrow money, but only about their estimates of the borrowing rate between two global banks. Especially today, this originates a clear difference between the real cost of borrow money between European banks and the referential rate that it supposedly reflects it.

To sum up, the affaire of the Libor and its cousin the Euribor, not only has brought about, with a flavor of a crime novel, the coming into scenery of diverse characters, billions of dollars, judicial procedures and surprising stories. It also reveals a little explored technical angle, perhaps more interesting than the novel, that will continue evolving… in various acts.

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