WASHINGTON -- Treasury Secretary Timothy Geithner has so far escaped responsibility for the spreading Libor fixing scandal by releasing documents showing that when he became aware of the problem in 2008, as head of the Federal Reserve Bank of New York, he made recommendations to address it.
"The New York Fed analysis culminated in a set of recommendations to reform LIBOR, which was finalized in late May. On June 1, 2008, Mr. Geithner emailed Mervyn King, the Governor of the Bank of England, a report, entitled 'Recommendations for Enhancing the Credibility of LIBOR,'" a Fed statement released Friday reads. "As is clear from the work culminating in the report to Mr. King of the Bank of England, the New York Fed helped to identify problems related to LIBOR and press the relevant authorities in the UK to reform this London-based rate."
With that, Geithner earned a rash of headlines focused on his foresight, as well as criticism for the cozy relationship between regulators and bankers that had led to the controversy.
But the Fed, along with its statement, also released the staff work that led to the recommendations. Those documents reveal that the recommendations Geithner sent to London did not come from staff, but rather were proposed by major banks and more or less forwarded on verbatim.
The policy recommendations Geithner forwarded in an attachment on June 1 first appear in a staff memo dated May 20 that reads: "A variety of changes aimed at enhancing LIBOR's credibility has been proposed by market participants, and seem to be under consideration by the BBA. These proposed changes include, but are not limited to..."
A comparison between Geithner's recommendations and those put forward by "market participants" -- shorthand for banks -- makes it clear that Fed staff asked banks how to fix the problem, then presented those answers as their own. (Most of the banks consulted were likely U.S.-based institutions, as several of the recommendations are aimed at giving more power, not surprisingly, to U.S. banks.)
Below are excerpts from the recommendations, side by side:
Geithner: Strengthen governance and establish a credible reporting procedure. To improve the integrity and transparency of the rate-setting process, we recommend the BBA work with LIBOR panel banks to establish and publish best practices for calculating and reporting rates, including procedures designed to prevent accidental or deliberate misreporting. The BBA could require that a reporting bank's internal and external auditors confirm adherence to these best practices and attest to the accuracy of banks' LIBOR rates.
Banks: lmplementing an audit process designed to ensure that reporting procedures and quotes adhere to an agreed and published set of best practices.
Geithner: Increase the size and broaden the composition of the USD panel. The BBA should increase both the size and tile proportion of US banks on the USD panel. Currently, the only US banks on the panel are Bank of America, Citibank, and JPMorgan, but there are several other US banks active in tills market and potentially eligible for inclusion in the panel, including Wachovia, State Street, Northern Trust, and BoNY.
Banks: lncreasing the size of the panel and including more US institutions, so that the resulting rate is more representative of the global demand for unsecured interbank dollar funding, and less susceptible to issues concentrated within any particular region's banking sector.
Geithner: Add a second USD LIBOR fixing for the U.S. market. The BBA should consider adding a second USD fixing to capture rates for transactions that occur when the US market is active.
Banks: Changing the time of the fixing, or adding a second fixing that occurs when US-based sources of dollar funding are active.
Geithner: Specify transaction size. … [T]o reflect the fact that actual transaction sizes can fluctuate markedly with changes in market conditions, the BBA should consider allowing the transaction size it specifies to adjust flexibly over time, with these adjustments occurring either at regular frequency in response to significant changes in market conditions.
Banks: Specifying transaction size, which could adjust flexibly to market conditions.
Geithner: Only report the LIBOR maturities for which there is a net benefit.
We recommend that, in consultation with panel banks, the BBA adopt guidance on consistent methods for determining quotes across the range of maturities of LIBOR. In addition, we recommend that the 13BA consider reducing the number of maturities for which it solicits quotes and publishes rates. For tenors such as the 3-month tenor, LIBOR quotes provide valuable information to the public because of the volume of activity occurring at that tenor, while quotes for tenors at which little or no trading occurs, such as the 11-month, are less indicative and therefore less valuable. The current practice of soliciting rate quotes across 15 tenors, when only a subset of those tenors reflect meaningful market activity, likely leads to more subjective and formulaic responses across all tenors. By asking banks to quote fewer rates, the BBA may solicit higher quality responses for those more informative tenors, with relatively little value lost by excluding less informative tenors.
Banks: Reducing the number of maturities quoted. The high number of maturities may lead to formulaic responses, and it is not clear that the market highly values, for example, a 7-month LIBOR quote. A key issue here may be the existence of derivatives contracts that reference all existing maturities.
Geithner: Eliminate incentive to misreport. If the combination of best practices and audit recommendations in (1) above seems unlikely to be sufficiently effective in ensuring accurate reporting, a complementary approach might be to adopt the following process for collecting, calculating, and publishing LIBOR rates. The BBA could collect quotes from all members of the expanded panel, and then randomly select a subset of 16 banks from which the trimmed mean would be calculated. The names and quotes for the 8 banks whose rates are averaged to calculate the LIBOR fixing would be published. The banks whose reports fall above or below the midrange would not be publicly identified, nor would the level of their outlying rates. This random sampling from an expanded panel would lessen the likelihood that the market would draw a negative inference regarding a particular bank's continued absence from the list of published quotes.
Banks: Making some or all of the individual quotes anonymous, so that even if the quotes refer to own-borrowing rates, banks at the high-end of the rate spectrum won't fear reporting accurately.
A Treasury spokesperson referred questions to the New York Fed. A Fed spokesperson said that the proposals put forward were the result of the bank's own analysis.
"The recommendations made by the New York Fed to the Bank of England to address the well publicized problems with LIBOR were the result of its own analysis by its economists and market specialists of what it considered to be the best solution to those problems," said the spokesperson in a statement.
Indeed, some of the proposals put forward by banks were not included in Geithner's list of suggestions. And one element of Geithner's set of proposals -- to randomize and anonymize the submissions, rather than just anonymize them -- did not come directly from Wall Street, according to the documents.
This article was updated to include comment from a spokesperson for the New York Fed.
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