The LIBOR Scam, Not At All Subtle….Gone on For A Long, Long Time….

The “new” LIBOR scam has been round for quite some time…..
Finally, we present suggestive evidence that the misreporting incentives are partially driven by
member bank portfolio positions. We nd that several banks in the U.S. Libor panel have very
large interest rate derivative portfolios, have signicant unhedged exposures to U.S. interest rates,
and have proted from their interest rate derivative portfolios during the rapid descent of the Libor
during 2009. We also argue the direction of bank skewing behavior is consistent with these portfolio
incentives. We then examine banks included in several currency Libor panels who have nancial
incentives to raise some of the Libor rates and to lower the other rates. We nd, as our model
predicts, that they simultaneously submit quotes near the upper and lower pivotal points in the
respective currencies.
Our nal source of evidence comes from the intraday distribution of bank quotes. First we nd
that, relative to CDS spreads, Libor quotes are closely clustered together. Prior to August 2007,
banks in the U.S. Libor panel submitted similar, often identical quotes. In this pre-crisis period,
the CDS spreads for panel banks have also been similar and low. This behavior changed with the
onset of the nancial crisis in 2007, with the intra-day variation of both Libor quotes and CDS
spreads increasing from their historical levels. The intra-day variation of CDS spreads, however,
grew considerably larger than that of Libor quotes. Figure 3 shows histograms of 12 month Libor
quotes, normalized by subtracting the value of the day’s fourth highest quote for each bank quote.
An identical procedure is performed for 1 year CDS spreads.7 Libor quotes are much more clustered
around the day’s fourth lowest quote than CDS spreads are of the fourth lowest spread. If banks
were truthfully quoting their costs, however, we would expect these distributions to be similar.
There are several possible explanations for the bunching of quotes around the fourth lowest.
The one that we pursue here is that some banks have incentive to alter the rate of the overall Libor
and the bunching is a result of these incentives interacting with the rate setting mechanism. In
the model that we lay out formally in the appendix, a bank’s payo, vis a vis it quote, is the sum
of two terms. The rst term is proportional to the Libor x and captures the bank’s incentives to
change the rate. The second term is the cost”of misreprorting, for example the cost of a BBA
investigation, which is triggered by unusual quotes. Bank incentives interact with the truncated
averaging mechanism of the Libor.
Having established evidence of misreporting, we now turn our attention to the sources of misreporting
incentives. We argue bank portfolio exposure to the Libor is a good candidate for generating
these incentives. In general, these portfolio positions are opaque and for this reason we focus our
analysis on the three American bank holding companies. These banks are required to provide information
about their interest rate derivatives and net interest revenue in the quarterly Reports on
Conditions and Income (Call Reports) to the FDIC.
https://www.econ.umn.edu/~youle001/libor_4_01_10.pdf