Libor: London's illogical, bungled opportunity (to) rebut

The initials stand, of course, for the London Interbank Offered Rate. This is the interest rate which banks charge to borrow from each other – typically expressed in dollar, sterling or euro terms, although a Libor rate is available for many currencies of commerce.

It is calculated each day by referencing the actual rates applied by a pool of banks for overnight, one-month and three-month money. Libor is the benchmark of benchmarks. It is used as the reference point in the pricing of just about every sizeable corporate loan and/or debt security in the world.

But it's been playing up of late – another symptom of the Great Credit Crisis, which has yet to depart the Western financial system. In short, the gap between official interest rates, as set by the Federal Reserve or the Bank of England, for example, and the relevant Libor rate has remained stubbornly wide.

Rather than bobbing around at a tight margin, the so-called 'spread' has become painful.

This is commonly seen as an expression of continuing fear and uncertainty in the system – a raw pointer to the fact that banks don't trust each other as well as they used to.

What's more, the persistence of relatively high real interest rates stymies official monetary policy and makes it more likely that the major economies of the West will be plunged into recession, if they are not there already. Now, back in March something controversial happened.

The Bank for International Settlements in Switzerland, which sets standards for just about everything banking related, said that some banks were quoting fictitious numbers when asked to provide data used in calculating Libor.

The implication was that at the height of the crisis, some banks didn't want others to know how pressed they were. Libor, as the name suggests, is very much a London-centric concept.

Indeed, it is calculated each day just before lunch by the British Bankers Association, which easily conjures up images of rotund old men doing a spot of work before sitting down for a good roast lunch, a spot of Stilton cheese and a glass of port.

So when the BIS made its assertion that some of the numbers making up Libor may have been wrong, a nationalistic outcry swept across Wall Street. "The Brits are to blame," came the allegation from New York. No matter that crooked American mortgage brokers had sold zillions in mortgages to people who couldn't pay the money back, putting a torch to $400bn of related financial assets. The Credit Crisis was suddenly London's fault!

This vaguely comic notion might have passed in a day or two, but for the American media and a few opportunistic financial types, who set about trying to prove that Libor was an unreliable benchmark.

Despite the fact that literally trillions of dollars of debt is already tied to Libor, pressure to create a new American standard persisted – causing the British Bankers Association to undertake a review of the matter.

As recently as last week, the Wall Street Journal published a major analysis of Libor, concluding that the benchmark was fundamentally flawed.

The Journal's work was immediately torn to shreds by big investment banks – including American ones, like JPMorgan, which pointed out numerous fundamental flaws in their Journal's own understanding of how the interbank lending market works. No matter.

The Journal had ensured that all eyes would be on the BBA's review, which was slated for publication on Friday afternoon. So here are the results of that review, undertaken amid the greatest modern crisis ever to engulf this august institution: "The committee will be strengthening the oversight of BBA Libor. The details will be published in due course."

That was it. Everything else in the BBA's communication was padding – a series of lists of all the banks that contribute prices for the calculation of Libor, along with a series of notes saying each list of banks would remain unchanged.

There was no defence of the Libor process, no rebuttal of what have occasionally been truly ignorant criticisms. Nothing! Just a statement saying there would be a strengthening of oversight (whatever that means) and that details would be published in due course (whenever that might arrive).

Now, this could be taken as evidence that the BBA is supremely arrogant, choosing to say absolutely nothing in response to its critics – deciding not to be cowed by ignorant types in the financial media, perhaps. Or it could be evidence that the BBA is all at sea, that it doesn't know what to do or how to respond – saying it will report back later, hoping the issue will somehow go away.

Either way, we should expect howls of protest over the coming weeks. The blood of crusty old London bankers will be spilt here, not just the odd glass of port.

- Paul Murphy is associate editor of the Financial Times

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