Diagnosing the LIBOR: Strategic Manipulation and Member Portfolio Positions (Abstract of Report)

3/10/2006 Barclays (source: FSA.gov.uk, 6/27/2012)
Here's an interesting read on LIBOR manipulation from 2009 given the current LIBOR and Euribor scandal at Barclays, and soon to be other banks. The report has some nice charts in it (tweeted by @carney). To your right are snapshots of emails from Barclays' interest rate derivative traders to their LIBOR submitter on March 10, 2006 (via the Financial Services Authority).

Diagnosing the LIBOR: Strategic Manipulation and Member Portfolio Positions

Connan Snider

Thomas Youley
University of Minnesota

February 7, 2009
Preliminary and Incomplete


The London Interbank Offered Rate (Libor) is a vital benchmark interest rate to which hundreds of trillions of dollars of financial contracts are tied. We provide new evidence that panel banks may have misreported actual borrowing costs when quoting rates to the Libor survey. This evidence stems from discontinuities involved in the Libor's construction. We introduce a simple model where banks' possession of Libor indexed contracts leads them to quote rates that are clustered at discontinuities and show that such clustering has been severe in the 3-Month U.S. Libor throughout 2009. We then present suggestive evidence that several banks have large exposures to the Libor through their interest rate derivative portfolios and have recently profited from the rapid descent of the Libor.

Continue reading here or here. And read this by the authors: Does the LIBOR reflect banks' borrowing costs? (April 2, 2010).

Barclays' LIBOR, Euribor and Interest Rate Derivatives Scandal VIX is Spiking, On Cover of The Economist

The Economist (source: Google+)
I haven't officially posted about the LIBOR (London Interbank Offered Rate) and interest rate derivative trading scandal yet, but it's definitely crazy that $350 trillion of notional interest rate swaps and $437 trillion of CME Eurodollar futures notional volume (in 2009), all tied to LIBOR, have been manipulated by LIBOR "submitters" and interest rate derivative traders at Barclays (and other big banks?) from 2005-2009 (CFTC vs. Barclays). The CFTC document also said that Barclays manipulated Euribor for its traders and colluded with other banks. And not only that, Barclays manipulated its rate to be perceived as a healthier credit during the credit crisis. And was the Bank of England involved with that? So, this is why the scandal is perceived as such a big deal, even if it just involved a few basis points at a time. It is also another blow to the credibility of the bailed out too-big-too-fail financial system now that (legal) credit fraud contagion has officially spread to interest rates (to the public at least). According to the CFTC, LIBOR sets the rate on $10 trillion of variable rate loans.

I've covered LIBOR on this blog before. LIBOR is the "trimmed average" of interbank lending rates submitted by banks to price short-term credit risk in the banking system (overnight, 1-week, 1-month, 3-month, 6-month etc). Read more details at the British Bankers Association's website. LIBOR was the most important rate to watch during the 2008 financial crisis to see if the Fed could save the financial system (unfreeze liquidity) when all of the banks were headed to zero (see posts: 1, 2, 3). And LIBOR also moved higher when the sovereign debt crisis in the euro zone started to flare up (1, 2). So these rates are no joke. And I think we now know why the Eurodollar COT predicts the S&P 500 one year in advance! Ha. So, after knowing all of this, how did the banks not profit from their own credit crisis in 2008?

Unmasking the Asian Giant - Guest Post

Guest post by Frank Holmes, CEO and CIO of U.S. Global Investors.

July 2012
Unmasking the Asian Giant

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

Chinese operas have been keeping audiences enthralled for hundreds of years with mythical characters, enchanting stories and elaborate masks that add drama and mystery. While this fantastical treatment is appreciated in the theatre, it isn’t in global markets. Investors don’t like mystery—think of how uncertainty has spooked markets in recent years.

Global investors are rarely privy to every detail about the economy; that’s why it’s necessary to rely on multiple data and research to make decisions and be cautious of extreme views that unnecessarily arouse suspicion, skepticism, and criticism. These opinions may grab headlines, but rarely do they help investors’ portfolios.

A recent article in The New York Times raised doubts about the quality in China’s macroeconomic reporting. The Times pointed to evidence from “prominent corporate executives in China and Western economists” who say that “local and provincial officials are falsifying economic statistics to disguise the true depth of the troubles.” The author alarmed many of our readers, so we immediately contacted numerous analysts—many of whom have front row seats to Chinese economic data—to get their reaction.

How is the Keystone XL Pipeline Progressing? -- Guest Post

source: NPR/Transcanada
Guest post by Jen Alic of OilPrice.com

How is the Keystone XL Pipeline Progressing?

Four and a half years of studies and five failed votes in the House later, exactly where are we with the Keystone XL pipeline? Stuck on the US-Canadian border where it is likely to remain until mid-2013 despite the headline-grabbing issuance of one of three permits to begin construction in Texas for the smaller and much less controversial portion of the pipeline.

On 26 June, the US Army Corps of Engineers granted TransCanada Corp one of three permits required in order to begin construction on the $2.3 billion southern section of the Keystone XL pipeline, which would run from Cushing, Oklahoma to the Gulf of Mexico in Texas. This first in the permit series covers construction across the wetlands and waterways of Texas' Galveston district. TransCanada still needs to more permits from Tulsa, Oklahoma and Forth Worth, Texas, to complete this southern Gulf portion of the pipeline extension. Tulsa is set to rule on the second permit in a month and a half.

Euro Gets Slaughtered After ECB Cuts Rates (EUR/USD)

Source: FreeStockCharts.com
EUR/USD is getting slaughtered after the ECB cut rates (trading at 1.2383, -1.14%). It also broke (or pierced) through symmetrical triangle support just now. We'll see what kind of relief rally there is today. Below I quoted the ECB's rate decisions via ecb.int. E-mini S&P is up 0.18%. Interesting morning so far.

5 July 2012 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

  1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.75%, starting from the operation to be settled on 11 July 2012.

  2. The interest rate on the marginal lending facility will be decreased by 25 basis points to 1.50%, with effect from 11 July 2012.

  3. The interest rate on the deposit facility will be decreased by 25 basis points to 0.00%, with effect from 11 July 2012.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.

EUR/USD Ahead of ECB Meeting (1.25011)

EUR/USD is down 0.20% at 1.25011 ahead of the ECB's rate decision. Economists expect the ECB to lower its benchmark rate by 25 basis points to 0.75%. Watch for a symmetrical triangle breakout.

via freestockcharts.com

Previous post: EUR/USD Testing Ceiling Resistance In Symmetrical Triangle In Overall Descending Channel (Chart)

Chart of LTCM's Performance vs. Dow, U.S. Treasuries (1994-1998)

Source: Wikimedia Commons
More from Wikipedia:

"The company, which was providing annual returns of almost 40% up to this point, experienced a flight-to-liquidity. In the first three weeks of September, LTCM's equity tumbled from $2.3 billion at the start of the month to just $400 million by September 25. With liabilities still over $100 billion, this translated to an effective leverage ratio of more than 250-to-1.[22]"

Former CFTC Chair Brooksley Born Warning About Systemic Risk in OTC Derivatives Market In 1999 After Hedge Fund LTCM Blew Up (Text)

source: Wikipedia
Former CFTC Chair (1996-1999) Brooksley Born continued to warn about systemic risk in the OTC derivatives market even after the hedge fund Long Term Capital Management L.P., which was managed by mathematical geniuses, "nearly defaulted on $1.25 trillion in notional value of exchange-traded and OTC derivatives contracts" in 1998. Maybe it's time to stop listening to Alan Greenspan and other seasoned pro-TBTF finance professionals and OTC traders brainwashed by TBTF bank academia, realize internal bank fraud (control fraud - Bill Black, Janet Tavakoli) destroys the free markets and risk management practices, and breakup the too-big-to-fail banks before finance gets destroyed. At the end of 2011, the total notional value of OTC derivatives outstanding stood at $647 trillion, with insured commercial banks holding $222 trillion of derivatives (less $8 trillion of exchange traded derivatives). *I added text from her last testimony before the U.S. House Committee on Agriculture on May 18, 1999 where she talks about OTC derivatives and hedge funds.

Source: cftc.gov



Boca Raton, Florida
March 18, 1999

It is a pleasure to be here this morning to address the members of the Futures Industry Association. I look forward to an extremely interesting conference this year as the industry addresses many of the issues confronting it in this era of profound change.

It is difficult to imagine a time of greater change in this industry. Electronic trading systems are replacing floor trading at exchanges around the world. The ultimate role of intermediaries in these new systems is not yet clear. Moreover, instantaneous international communication and transactional capabilities are creating truly global markets. Consequently, domestic exchanges and industry professionals are eager to offer their products and services to customers abroad, while foreign exchanges are just as eager to offer their products to U.S. customers. While futures exchanges are grappling with these technological developments, the number and type of derivative products offered over-the-counter continues to mushroom even as the volume of transactions in that market increases exponentially. Furthermore, technological and market developments are driving many OTC derivatives market participants to express an interest in adopting trading and clearing systems that would cause the OTC market to resemble more closely the exchange-traded markets.

EUR/USD Testing Ceiling Resistance In Symmetrical Triangle In Overall Descending Channel (Chart)

Here's a quick technical update on EUR/USD (Euro/US Dollar). As you can see on the chart below, EUR/USD has been trading in a descending channel since August 2011. More recently, EUR/USD broke through the January 13 support level of 1.26244 on May 23, bottomed out at 1.22822 on June 1, and is now trading at 1.25879. EUR/USD pierced through the new ceiling resistance level (1.26244) a few times in June, but there was no confirmed breakout.

It is finally time for EUR/USD to make a decision as it nears the apex point in a near-term symmetrical triangle (higher lows and lower highs will force a decision soon). If EUR/USD can confirm a breakout above 1.26244 (part 1 after Euro summit), I think it could rally to the overall downtrend line from August 2011 (1.29s it looks like, but it hits 1.28 towards the end of July). However, the overall trend for EUR/USD is still down. But if it can break through that downtrend line from 2011 and 1.30 ceiling resistance level, I think that would catalyze a strong move to the upside. It would break the descending channel. I'll do a new post on this when (or if) EUR/USD tests those levels in the future. The currency pair is currently reacting to the euro zone sovereign debt and banking crisis, Greece potentially leaving the euro zone, Spanish bank risk, Germany's involvement with the bailouts (watch German bunds), the *European Central Bank, the Federal Reserve, U.S. fiscal cliff risk, U.S recession risk, and a possible hard landing in China. *According to Bloomberg, economists expect the ECB to cut its benchmark rate by 25 basis points to 0.75% on Thursday.

Ray Dalio on How Deleveragings Work (PDF Link)

Ray Dalio at Hedge Fund Industry Awards (video)
Ray Dalio, founder of Bridgewater Associates, the largest hedge fund in the world with $120 billion under management, explained to you how the economic machine works in a research report (pdf) and on Bloomberg TV last year. Now I see he has a research report out on how deleveragings work (pdf from February). Read the intro below. I remember he said recently that the U.S. was going through a "beautiful deleverging" at the moment. Fiscal tightening could change that.

"An In-Depth Look at Deleveragings
Ray Dalio
February, 2012

The purpose of this paper is to show the compositions of past deleveragings and, through this process, to convey in-depth, how the deleveraging process works.

Microsoft Takes $6.2 Billion Writedown On $6.3B aQuantive Acquisition in 2007 (Online Advertising)

In online advertising tech news, Microsoft is taking a $6.2 billion writedown on assets in its "Online Services Division" (a non-cash impairment charge on goodwill), which, according to the release, was related to its $6.3 acquisition of aQuantive in 2007. I did more research on aQuantive and saw that it owned the digital ad firm Razorfish, which MSFT then sold to French firm Publicis Groupe for $530 million in 2009. I actually just passed a Razorfish office in Chicago's Merchandise Mart. Here is a post I did a few days ago on how to reinvent internet advertising. How about hologram ads (see below).

JPMorgan Global Manufacturing PMI Falls to 3-Year Low in June

The chart says a thousand words. Read the full release here.

"Global Manufacturing Sector Contracts in June

source: ISM
The JPMorgan Global Manufacturing PMI™ — a composite index produced by JPMorgan and Markit in association with ISM and IFPSM — fell to three-year low of 48.9 in June, a reading below the neutral 50.0 mark for the first time since November 2011.

Manufacturing production declined for only the second time in the past three years. Although the rate of contraction was only moderate, it was nonetheless the fastest since May 2009. Growth slowed sharply in the US to its weakest in the current 37-month sequence of expansion. Rates of decline gathered pace in China, Brazil and Vietnam, while Japan, South Korea and Taiwan all fell back into contraction.

The Eurozone remained the main source of weakness for the global manufacturing sector. Production in the euro area contracted at a similarly sharp rate to May – which was the steepest drop in almost three years – with declines recorded in Germany, France, Italy, Spain and Greece...." (continue reading)

PIMCO's Bill Gross: "U.S. Treasuries Are One Giant PIK Bond"

Source: PIMCO
Bill Gross, co-founder of PIMCO and manager of the $260 billion PIMCO Total Return Fund, wrote in his July Investment Outlook that the global debt crisis, which is currently flaring up in the euro area, still hasn't been cured, and will eventually end up in the United States if debt/GDP and other government liabilities (some unfunded) keep trending higher. He provided a chart of U.S. Gross Federal Debt/GDP. And we have an economy that can't survive without stimulus, right? Markets will be interesting to watch during the fiscal cliff fiasco at the end of the year. Can't LIBOR fraud at the TBTF banks get us out of this mess?

"But when debt as a percentage of GDP, or debt service as a percentage of household income, or the appropriateness of the term structure (short vs. long) on both borrower and lender balance sheets becomes imbalanced, then the well-oiled capitalistic engine may sputter and in some cases – as in Greece – freeze up.

China's Manufacturing (PMI) Barely Expands in June, Input Prices Crash, Export Orders Contract (Interactive Chart)

China PMI, input prices, export orders (static)
China's manufacturing activity barely expanded in June, according to the official PMI (purchasing managers' index) released by China's National Bureau of Statistics and CFLP. China's overall PMI fell to 50.2 in June from 50.4 in May, but was higher than both Bloomberg and Dow Jones' median economist estimates of 49.9 and 49.8 (under 50 = contraction).

When breaking out the PMI data, China's input prices crashed to 41.2 in June from 44.8 in May, and export orders fell to 47.5 in June from 50.4 in May. If you've been watching the HSBC China Manufacturing PMI chart, this weakness was expected. I created an interactive monthly chart comparing China's overall PMI, input prices, and export orders from October 2011 to June 2012 using Thomson Reuters data (via xe.com). Since the PMI showed that China's manufacturing growth was still trending down, and aggressive input price contraction increased deflation risk, traders will be watching to see if China's central bank lowers interest rates and the bank RRR (reserve requirement ratio) again in the third quarter to stimulate the economy.