News of the Day: Libor, Blackrock, Ann Coulter
Libor
You might have heard or read about Libor in the news a few years back. It stands for Lonond Interbank Offered Rate. The basic idea here is that if you are a bank and someone comes to you asking you to lend some money. You do your due diligence and determine the appropriate amount you can lend. Then you have to determine how much to charge for your funds. What you do is look at some baseline rate and add a premium based on the probability that the borrower will default. The idea here is that while you want to be competitive in terms of your offer, the baseline has to reflect the cost of the funds for you because as it is you might not have cash on hand to offer it to the borrower. What you do is go out in the market find another bank and borrow from them, that will be your cost of the funds. As the banks kept trading more new type of instruments such as interest rate swaps, currency options and forward rate agreements introducing a baseline rate shared among multiple banks to link these new securities to became more and more important. The compiled average of these baseline rates became Libor.
As mentioned earlier this rate was in the news due to fraudulent behavior for some of the member banks that provided data for Libor computation. Nonetheless this rate is crucial for the functioning of the global financial system as it underpins many financial instruments ranging from loans to derivatives. The recent turmoil in the markets however introduced some issues as Robert Smith points out:
Three-month dollar Libor rates are normally in synch with the equivalent term of unsecured commercial paper (CP) from banks, but this relationship started to break down on March 10 as skittish investors bought up the short-term debt, even at overnight tenors.
According to an interest rate strategist at a US bank, it’s likely that levels would have needed to be implied from transactions in the level three bucket, which includes short-dated cross-currency swaps and foreign exchange swaps. These markets were also under stress on the back of dollar funding pressures, leading to volatility in the Libor rate and its decoupling from the CP market, the strategist says.
This means that Libor currently does not reflect the underlying baseline borrowing rate for the banks well. In other words it is unclear whether their borrowing costs are in sync with the rate that determines a lot of their payouts. In order to safeguard against unexpected market turmoil, regulators have developed capital requirements and other measures including stress tests for the banks. The problem is that this scenario of CPs decoupling from Libor was not included in stress test scenarios. Another headache for the Fed to deal with.
Blackrock
Speaking of the Fed the yesterday it has announced it will enlist Blackrock in its debt buying program. As Bloomberg reports:
BlackRock, the world’s largest asset manager, will serve as an investment adviser and manage assets for three separate programs, the New York Fed said Tuesday. Those include two new facilities the central bank announced Monday to provide liquidity to corporate borrowers, as well as purchases of agency commercial mortgage-backed securities.
The New York Fed said BlackRock was chosen for the role “after considering their expertise with purchasing large amounts of all relevant types of corporate debt issuance and corporate bonds in the secondary market, deep knowledge and substantial experience in the corporate debt markets, and robust operational and technological capabilities.”
The idea here, is that while Federal Reserve has pretty much an unlimited arsenal, it is limited by its human resources and corresponding expertise. The brightest minds in economics and modeling might not be the best people to execute buy orders from a logistics side. They also likely do not have the expertise to decide on the specific assets to purchase and this is where advice from Blackrock comes in. Blackrock is the largest asset manager in the world and is a poster boy for passive investing. I have talked about concerns around passive before and a theoretical possibility of everyone moving towards passive at once. Fed is once again leading the way.
Ann Coulter
Ok this isn’t really financial news but the other day I got twitter. It’s great but I frequently stumble that make me reassess whether being on this platform is worth it. Here is a tweet from a BEST SELLING author Ann Coulter from last night:
No. Please learn how to read graphs before using social media Ann.
