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Electronic copy available at: http://ssrn.com/abstract=1201389
Rosa M Abrantes-Metz * Principal
LECG LLC 675 Third Avenue, 26th Floor
New York, NY 10017
Michael Kraten Assistant Professor of Accounting
Sawyer Business School Suffolk University
40 Court Street Boston, MA 02108
Albert D Metz
Vice President and Senior Credit Officer Moodys Investors Service
7 World Trade Center at 250 Greenwich Street New York, NY 10007
Gim S Seow
Associate Professor of Accounting School of Business
University of Connecticut 2100 Hillside Road Storrs, CT 06269
Preliminary Comments are Welcome
August 4, 2008
* Contact author. E-mail: RAbrantes-Metz@lecg.com. Telephone: (212) 506-3981. The authors gratefully acknowledge the suggestions of Mukesh Bajaj, John Cochrane, John Connor, Guy Erb, George Judge, Cathy Niden, Sofia Villas-Boas, and the assistance of Marissa Rich, Shelly Yang, and especially Susan Press. The views expressed in this study belong solely to the authors and should not be attributed to the organizations with whom they are affiliated or their clients.
Electronic copy available at: http://ssrn.com/abstract=1201389
ABSTRACT On May 29, 2008, the Wall Street Journal (the Journal) printed an article that alleged that several global banks were reporting unjustifiably low borrowing costs for the calculation of the daily Libor benchmark. Specifically, the writers alleged that the banks were reporting costs that were significantly lower than the rates that were justified by bank-specific cost trend movements in the default insurance market. Although the Journal acknowledged that its analysis doesn't prove that banks are lying or manipulating Libor, it conjectured that these banks may have been low-balling their borrowing rates to avoid looking desperate for cash. In this paper, we extend the Journals study and perform the following analyses: (a) a comparison of Libor with other rates of short-term borrowing costs, (b) an evaluation of the individual bank quotes that were submitted to the British Banker's Association (BBA), and (c) a comparison of these individual quotes to individual CDS spreads and market cap data. We do so during the following three periods: 1/1/07 through 8/8/07 (Period 1), 8/9/07 through 4/16/08 (Period 2), and 4/17/08 through 5/30/08 (Period 3). We select these periods because three major news items were announced in the public press on August 9, 2007: (a) there was a coordinated intervention by the European Central Bank, the Federal Reserve Bank, and the Bank of Japan; (b) AIG warned that defaults were spreading beyond the subprime sector, and (c) BNP Paribas suspended three funds that held mortgage backed securities. Furthermore, on April 17, 2008, the Wall Street Journal first published the news that the BBA intended to investigate the composition of these rates. Individual Libor quotes are analyzed from January 2007 through May 2008, while the level of the Libor itself is studied from 1990 using Bloomberg data sources. After verifying that the patterns are essentially the same for the one month and three month Libor rates, we generally restrict our attention to the one month Libor. We also study data on other market indicators, both at aggregate levels and for the individual Libor banks. A few missing days are filled by linear interpolation. Our primary findings are that, while there are some apparent anomalies within the individual quotes, the evidence found is inconsistent with an effective manipulation of the level of the Libor. However, some questionable patterns exist with respect to the banks' daily Libor quotes, especially for the period ending on August 8, 2007, for which the intraday variance for banks quotes is not statistically different from zero. Key words: LIBOR, LIBOR quotes, manipulations, conspiracies, collusion, CDS spreads, market cap.
JEL classification: C10, C22, G14, G24, K20.
I. INTRODUCTION On May 29, 2008, the Wall Street Journal (the Journal) printed an article that alleged that several global banks were reporting unjustifiably low borrowing costs for the calculation of the daily Libor benchmark (Mollenkamp and Whitehouse, 2008). Specifically, the writers alleged that the banks were reporting costs that were significantly lower than the rates that were justified by bank-specific cost trend movements in the default insurance market. Although the Journal acknowledged that its analysis doesn't prove that banks are lying or manipulating Libor, it conjectured that these banks may have been low-balling their borrowing rates to avoid looking desperate for cash. The British Banker's Association (BBA)'s website claims that BBA Libor is the primary benchmark for short term interest rates globally. It is used as the basis for settlement of interest rate contracts on many of the worlds major futures and options exchanges (including LIFFE, Deutsche Term Brse, Euronext, SIMEX and TIFFE) as well as most Over the Counter (OTC) and lending transactions. Thus, for transactions that utilize Libor as a benchmark for establishing borrowing costs, a slight understatement of the rate may generate sizable wealth transfers from lenders to borrowers. Subsequent to the publication of the Wall Street Journal article, other major financial publications voiced similar concerns. On June 2, 2008, for instance, The Financial Times agreed that ... the rate of borrowing in Libor has lagged behind other market-based measures of unsecured funding used by the vast majority of financial institutions. This has aroused suspicions that the small group of banks which supply the BBA with Libor quotes have understated true borrowing rates so as not to fan fears (that) they have funding problems. (Mackenzie and Tett, 2008). The motivation of this study is to extend the Journal's analysis by employing a wider array of comparative statistical techniques and methodologies to gain a more thorough understanding of the issues underlying such speculations. While statistical methods alone do not prove that manipulation has occurred in a particular market, some questionable patterns do exist with respect to the banks' daily Libor quotes. Our analyses of these apparent anomalies within the individual quotes suggest that the evidence is inconsistent with an effective manipulation of Libor. Nevertheless, the analyses presented in this study demonstrate that distinct non-random patterns of reported borrowing costs did exist during distinct periods of time, patterns that go beyond the findings that were originally reported by the Journal. In particular, for the period ending on August 8, 2009, the intraday variance of individual quotes is not statistically different from zero, and the banks deciding group for the Libor includes almost the entirety of the sixteen banks for a period of over seven months.
II. THE POSSIBILITY OF COLLUSION AND MANIPULATION In 1984, the BBA sought to standardize rate terms on interest rate swaps between London based banks. Two years later, in 1986, the BBA introduced Libor to standardize rate terms on a wider variety of securities, including syndicated loans, futures contracts, and forward rate agreements. Today, Libor's primary function is to provide a point of reference for unsecured loans between London based banks. It is also used as a point of reference for a wide variety of securities contracts transacted across the globe. Libor rates are quoted daily on ten major currencies: Australian dollar, British pound, Canadian dollar, European euro, Danish krone, Japanese yen, New Zealand dollar, Swedish krona, Swiss franc, and US dollar. In this study, we focus on the US dollar Libor. The BBA selects only 16 banks to provide daily rate quotes for the calculation of Libor. The BBA website states that this reference panel of banks ... reflects the balance of the market by country and by type of institution. Individual banks are selected within this guiding principle on the basis of reputation, scale of market activity, and perceived expertise in the currency concerned. It is noteworthy that these factors do not include any consideration of net borrowing or lending positions. Because the "middle 8" quotes are converted into Libor through a simple arithmetic mean calculation, as few as 5 (of 16) banks, acting in concert, can conceivably affect the published Libor. What may motivate banks to artificially inflate or deflate rates? From a fiscal perspective, banks that are "net borrowers" would benefit from lower rates. Conversely, banks that are "net lenders" would benefit from higher rates. Although an analysis of the protocols employed to select Libor's 16 banks is beyond the scope of this study, the nature of the composition of this group might generate an opportunity for collusion if the majority of these banks tend to be net borrowers or net lenders.1 Collusion may generate non-fiscal benefits as well. The Journal has suggested that banks may use the Libor submission process to manage their perceived reputation and risk. In other words, they may use the Libor calculation process to signal to the market that their operating costs are lower (i.e. that they are more fiscally healthy) than they are in reality. Because Libor submissions are released to the general public, banks may also be able to utilize the process to signal to each other in much the same way as airlines use their online ticket reservation systems to communicate their pricing intentions.2 In addition, banks that operate in multiple global markets may be motivated to use Libor as a "hedge" (or, at a minimum, as an alternative financing resource) against rate fluctuations elsewhere. For instance, an American bank with operations in London might benefit by keeping Libor r