6 July 2012 – The Aleph Blog

Sorted Weekly Tweets

Posted on 6 July 2012 by David Merkel

LIBOR

Commented on The Economist | The LIBOR scandal: The rotten heart of finance $$ LIBOR may not be as rotten as advertised http://t.co/GfXH4hRq Jul 06, 2012
LIBOR scandal: The rotten heart of finance http://t.co/g2RBmaNy Proving actual damages will b tough; don’t think this will amount2much $$ Jul 05, 2012
Libor, central banks and financial stability http://t.co/9DBCcZaK The degree of damage from Libor-fixing is arguable; more analysis2come Jul 04, 2012
LIBOR: Everything You Want to Know, but were Afraid to Ask http://t.co/eYwKF68v Good summary article. $$ Jul 04, 2012

Eurozone

Europe Recalls Hamilton as Desperation Turns on the Debt http://t.co/K8RvS9dP Time running out; will EZone pull together or fly apart $$ Jul 07, 2012
This Is A Fantastic Presentation On Why ‘Germany Is Riskier Than You Think’ http://t.co/UPcEg8yS Cost: Support Euro < Abandon Euro $$ Jul 04, 2012
France Signals More Austerity http://t.co/gCiXPLKl Fascinating:Hollande may b delivering more conservative fiscal policy than Sarkozy $$ Jul 03, 2012

US Politics

Obama Fails to Gain as Unemployment Stuck Since March http://t.co/vX87x6vQ W/policy unsustainable, business owners reluctant 2 hire $$ Jul 06, 2012
Cities Consider Seizing Mortgages http://t.co/V9CKARiC Abuse of eminent domain will not hold up in court. Theft by another name. $$ Jul 05, 2012
How Stockton went broke: A 15-year spending binge http://t.co/VGy6fWv7 Offered enhanced employee benefits, which required no cash outlay $$ Jul 05, 2012
Thx 4 sharing this; worth the read $$ RT @LaurenLaCapra: How Stockton went broke: A 15-year spending binge | Reuters http://t.co/LK9VKq4q Jul 05, 2012
Yes, there is a free-market alternative to Obamacare http://t.co/gOpygz04 Support high deductible insurance, even if govt has2do it4the poor Jul 04, 2012
Who Is John…Allison? A Randian, Libertarian Business Icon Takes Over the Cato Institute http://t.co/Bms310O7 Met him @ #CMC29. Nice guy Jul 04, 2012
Debt Forgiveness Would Revive the Economy http://t.co/D5lkF7b6 @JamesGRickards argues this, as I have elsewhere: http://t.co/LdeYyBkh $$ Jul 03, 2012

Financial Markets

Big Board’s New Dark-Pool Ammo: Sub-Penny Quotes http://t.co/FgvZ7ebD I agree w/the guy quoted @ end; A step in the wrong direction $$ Jul 06, 2012
The High-Frequency Conspiracy http://t.co/iOs8buSu HFT and the market makers / specialists work together to extract $$ from stock traders. Jul 04, 2012
@TraderNewsFeed I don’t share that view; I think the GSEs deserve some blame, the Fed a lot of blame, & invt banks a lot of blame, but… $$ Jul 04, 2012
@TraderNewsFeed Pt 2, the investors deserve blame as well. U can’t have a derivative hedge without a yield hog seeking additional income $$ Jul 04, 2012
Tail Risk and Hedge Fund Returns http://t.co/uqcs0Bcg ht: @PragCapitalist As I have argued B4, hedge funds as a whole r short volatility $$ Jul 04, 2012
Blackstone Makes Foray Into Houses for Rent http://t.co/UaRvTRqE Economics of managing a lot of single family houses is difficult $$ Jul 04, 2012
Ex-JPMorgan Trader Feldstein Wins in Betting Against Bank http://t.co/pSfwA1xd This is a good example of how frenemies act on Wall Street Jul 04, 2012
The Changing Face of U.S. Equity Ownership http://t.co/aqQXXVFF Individuals own less, Institutions more; Graph: http://t.co/gb7M6RgY Jul 04, 2012
Stocks for Bond Lovers http://t.co/nzNrE6RA If dividends grow rapidly, a rising income stream beats bonds, if market value persists $$ Jul 04, 2012
Pimco’s Bond King Regains Investor Favor http://t.co/MwSZ8hUu Owning long Treasuries is too fashionable, think I have2sell $TLT FD: +TLT Jul 04, 2012
“There is a high correlation between stocks & anticipated inflation. $$ http://t.co/mKr4SFcn Aleph Blog article: http://t.co/MWBP9Ib7 Jul 03, 2012
Pimco?s El-Erian Says US, Emerging Markets R Top Investments http://t.co/LwbYAIzs EM r in good shape, US better than other big nations $$ Jul 03, 2012

China

For CFAs: China?s Fragile Foundations http://t.co/jwf1IJJB Fraser Howie of CLSA Asia-Pacific explains the economic weaknesses of China $$ Jul 05, 2012
China?s New Rules May Curb Credit Growth http://t.co/KQcRe9uQ Loosen with one hand; tighten w/the other. Now that’s a monetary policy $$ Jul 05, 2012
BRICs Priced for Economic Meltdown http://t.co/wTf6nRp9 It is the lack of “rule of law” that makes them cheap, not possible slump $$ Jul 04, 2012
Jim Chanos ?China Makes Greece and Spain Look Like Child?s Play? http://t.co/GA2woEwn Chanos is an accounting expert; sniffs out failures $$ Jul 03, 2012

Miscellaneous

Good for about 45 minutes as well, eh? $$ RT @BloombergNews: Central banks deliver 45-minute salvo as growth weakens http://t.co/MzlnAUXQ Jul 05, 2012
A New Market for Schools http://t.co/HbMuSfcK Be wary; costs of the degree including foregone wages may not be worth it. $$ Jul 05, 2012
The Green Mountain saga: a cup of joe to go http://t.co/uUPtr1Ht Once again, revenue policies take center stage for accounting quality $$ Jul 04, 2012
Loeb’s Third Point fund moves into Chesapeake http://t.co/3yYeKOhq The plot thickens, as a group of activist investors gathers $$ Jul 04, 2012
Contra: Carlyle Bets Big on U.S. Energy http://t.co/0bT7y1LM This does not look like a big bet to me. $$ Jul 04, 2012
Been experimenting with a spreadsheet that takes @yahoofinance news, and weeds out the chaff, I like it; improves quality, takes work $$ Jul 03, 2012
DNA Mapping of Alzheimer?s Patients Gives Deep Dive View http://t.co/L5M0ATIN May be promising, but not every disease is gene-based $$ Jul 03, 2012

Comments

“It will be very difficult to prove actual damages in these cases. I don’t think this will amount to much.” http://t.co/BP18Tw8D $$ Jul 05, 2012
“Organic growth is one of the toughest tasks in business, and also the most valuable.” ? David_Merkel http://t.co/T2MMseVx $$ $BLK Jul 05, 2012
“W/all of that liquidity, they can buy a bigger string to push on.” ? David_Merkel http://t.co/N0EOuYnB $$ http://t.co/P456cjMP Jul 05, 2012
“It’s lousy fiscal policy to subsidize things in oversupply, like homes and banks. No spillover?” ? David_Merkel http://t.co/AItUK466 $$ Jul 05, 2012
On second thought, thanks to all of my Twitter followers. I am honored that you want to listen to me & I will do my best to serve you $$ Jul 05, 2012
Many thanks to @Clarityspring, my 5,000th Twitter follower; never thought I would enjoy Twitter so much! Jul 05, 2012
Quirky, but interesting. http://t.co/RZSAG652 Jul 04, 2012
RE: @TheStreet_News I think all orders should be good for at least one second. Until them, I will use discretionary r? http://t.co/dxvv58RA Jul 03, 2012
“What a fragmented market: top 10 have ~45%. Not much of a story here. Next. $$” ? David_Merkel http://t.co/nChBIcF2 $JPM $BAC $C $DBK $BARC Jul 02, 2012
“Only one way to lower healthcare costs: move back to a first-party payer system. Individuals decide?” ? David_Merkel http://t.co/lGZaDFJW Jul 02, 2012
“Difficult proposition: choke the economy to achieve an uncertain environmental benefit.” ? David_Merkel http://t.co/ngsN5VdG $$ Jul 02, 2012

An Analysis of Three-Month LIBOR 2005-2008

Posted on 6 July 20126 July 2012 by David Merkel

I 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 JP Morgan was below the LIBOR consensus by more than Barclays was above it.? Why is JP Morgan 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 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, HBOS, Credit Suisse, and BTMU.? Others go low, like WestLB, Rabobank, JP Morgan, HSBC, Lloyds and Citi.? 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 RBS, maybe Deutsche.? 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, Deutsche, RBC, 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 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

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