Bailouts Prove Pale Substitutes for Market Trust: Mark Gilbert
Oct. 8 (Bloomberg) -- Every weekday, 16 bowler-hatted City gents meet at a secret London location. Flunkeys in red velvet jackets and white gloves serve swan canapes, port is passed to the left, and cigar smoke thickens the air. At 11 a.m., a gong sounds, and the financiers prepare to hold the world to ransom by dictating ever-higher interest rates for borrowers ranging from companies to homeowners to indebted students.
The gyrations in money-market rates and their disconnect with the monetary-policy intentions of central banks lend credence to the idea that a shadowy cabal of bankers is manipulating the daily suite of borrowing costs known as the London interbank offered rates, or Libor.
The truth, though mundane, is actually even more worrisome, since it suggests that yet another pillar of the global capital markets is built on quicksand. It turns out that in times of stress, the world of finance has no idea what the cost of money should be.
As things stand, the guys and girls responsible for responding to the British Bankers Association's daily question about what their banks would pay to borrow in various currencies and for differing tenures have no clue how to answer the question -- because there's no unsecured lending to guide them.
If they contribute rates that are too low, their compliance officers will ask questions. Pitch too high, and pesky financial journalists may start to suggest that their bank is the weakest horse in the glue factory.
Fiction and Guesswork
So if the variable interest rate that you pay on your mortgage, credit card, auto loan or company credit line is based on Libor -- and more than $390 trillion of debt is tied to the London reference rate -- then your borrowing costs are at the whim of fiction, guesswork, and whether the head of money markets at Hokey-Cokey Bank has a hangover or not.
Entries for yesterday's three-month dollar Libor fix, for example, ranged from 3.3 percent from WestLB AG to 5.05 percent from Barclays Plc, a gap of 175 basis points. In the first quarter of this year, the average gap between the submissions from those two banks was less than half a basis point, and never exceeded seven basis points.
The BBA names the banks and the individual rates they provide. In New York, a rival three-month rate that broker ICAP Plc began publishing on June 11 allows for anonymity, which might explain why ICAP's rate is about 45 basis points higher than Libor. The difference is another example of weakening trust.
Destroying Trust
It doesn't matter whether the U.S. gives its banks a $700 billion get-out-of-jail card, Europe guarantees all retail deposits, Australia slashes interest rates, and Russia buys a stake in Iceland for $5.4 billion -- banks won't lend to their kind, nor to companies, nor to home buyers, if they reckon the money won't be repaid.
Unfortunately, the authorities have helped to destroy trust. Knee-jerk responses to every twist and turn in the credit crisis smack of desperation. Allowing Lehman Brothers Holdings Inc. to go bang led to an ``absolute loss of confidence in markets,'' European Central Bank member Miguel Angel Fernandez Ordonez said yesterday.
History will probably judge that the decision to ban the short selling of a ridiculously wide range of stocks was a mistake of epic proportions. And suspending all equity trading in markets including those of Brazil, Russia, Ukraine and Iceland just makes investors fearful that they won't be able to get their money out until it is too late.
Solvency Scare
Governments need to find some way to separate the availability of credit from the cost of money. When loans are tied to Libor, both the supply and the price of money rely on the same shaky foundation, the perceived creditworthiness of financial institutions.
While the current mish-mash of money-market mechanisms funnels billions of dollars to financial institutions, the cash then gets trapped in the paranoia of today's solvency scare. It doesn't make it into the wider economy. Central banks may need to lend directly to companies and consumers, cutting out the dangerous, unreliable middlemen of the markets.
Borrowers, meantime, should consider untangling their economic destinies from those of the banks. Maybe Libor should be allowed to wither; instead, link borrowing costs directly to central-bank rates, or to swap-market rates, or even the credit- default swap rates of non-financial companies.
The various treatments offered by governments until now have failed because placebos don't work when the patient knows that the medicine is fake. Until some semblance of trust returns to financial markets, nobody will know the value of a dollar, a euro, a pound or a yen.
Oct. 8 (Bloomberg) -- Every weekday, 16 bowler-hatted City gents meet at a secret London location. Flunkeys in red velvet jackets and white gloves serve swan canapes, port is passed to the left, and cigar smoke thickens the air. At 11 a.m., a gong sounds, and the financiers prepare to hold the world to ransom by dictating ever-higher interest rates for borrowers ranging from companies to homeowners to indebted students.
The gyrations in money-market rates and their disconnect with the monetary-policy intentions of central banks lend credence to the idea that a shadowy cabal of bankers is manipulating the daily suite of borrowing costs known as the London interbank offered rates, or Libor.
The truth, though mundane, is actually even more worrisome, since it suggests that yet another pillar of the global capital markets is built on quicksand. It turns out that in times of stress, the world of finance has no idea what the cost of money should be.
As things stand, the guys and girls responsible for responding to the British Bankers Association's daily question about what their banks would pay to borrow in various currencies and for differing tenures have no clue how to answer the question -- because there's no unsecured lending to guide them.
If they contribute rates that are too low, their compliance officers will ask questions. Pitch too high, and pesky financial journalists may start to suggest that their bank is the weakest horse in the glue factory.
Fiction and Guesswork
So if the variable interest rate that you pay on your mortgage, credit card, auto loan or company credit line is based on Libor -- and more than $390 trillion of debt is tied to the London reference rate -- then your borrowing costs are at the whim of fiction, guesswork, and whether the head of money markets at Hokey-Cokey Bank has a hangover or not.
Entries for yesterday's three-month dollar Libor fix, for example, ranged from 3.3 percent from WestLB AG to 5.05 percent from Barclays Plc, a gap of 175 basis points. In the first quarter of this year, the average gap between the submissions from those two banks was less than half a basis point, and never exceeded seven basis points.
The BBA names the banks and the individual rates they provide. In New York, a rival three-month rate that broker ICAP Plc began publishing on June 11 allows for anonymity, which might explain why ICAP's rate is about 45 basis points higher than Libor. The difference is another example of weakening trust.
Destroying Trust
It doesn't matter whether the U.S. gives its banks a $700 billion get-out-of-jail card, Europe guarantees all retail deposits, Australia slashes interest rates, and Russia buys a stake in Iceland for $5.4 billion -- banks won't lend to their kind, nor to companies, nor to home buyers, if they reckon the money won't be repaid.
Unfortunately, the authorities have helped to destroy trust. Knee-jerk responses to every twist and turn in the credit crisis smack of desperation. Allowing Lehman Brothers Holdings Inc. to go bang led to an ``absolute loss of confidence in markets,'' European Central Bank member Miguel Angel Fernandez Ordonez said yesterday.
History will probably judge that the decision to ban the short selling of a ridiculously wide range of stocks was a mistake of epic proportions. And suspending all equity trading in markets including those of Brazil, Russia, Ukraine and Iceland just makes investors fearful that they won't be able to get their money out until it is too late.
Solvency Scare
Governments need to find some way to separate the availability of credit from the cost of money. When loans are tied to Libor, both the supply and the price of money rely on the same shaky foundation, the perceived creditworthiness of financial institutions.
While the current mish-mash of money-market mechanisms funnels billions of dollars to financial institutions, the cash then gets trapped in the paranoia of today's solvency scare. It doesn't make it into the wider economy. Central banks may need to lend directly to companies and consumers, cutting out the dangerous, unreliable middlemen of the markets.
Borrowers, meantime, should consider untangling their economic destinies from those of the banks. Maybe Libor should be allowed to wither; instead, link borrowing costs directly to central-bank rates, or to swap-market rates, or even the credit- default swap rates of non-financial companies.
The various treatments offered by governments until now have failed because placebos don't work when the patient knows that the medicine is fake. Until some semblance of trust returns to financial markets, nobody will know the value of a dollar, a euro, a pound or a yen.
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