Custom Search

Thursday, September 25, 2008

The Libor And Why You Should Know It

I don't know much about economics. I never took Econ 101, and most of what I know I've gleaned from reading Adam Smith or listening to my father. Not very contemporary or altogether reliable sources, those. I've always wondered what the banks take into account when they set their rates. I know they take the Fed's exchange rate into account, but that does not change on a daily basis. International banking must use a more precise indicator.

They do. It's called the Libor (British Bankers’ Association’s London Interbank Offered Rate). The Libor is the rate at which British money traders make their transactions. You can find all of this out and more in this week's London Review of Books.

Brokers in major money-market currencies don’t work as individuals, but in teams of up to a dozen or more, sitting close together in subsections of large, open-plan offices. Good eyesight is useful – trainees still sometimes called ‘board boys’ write unfilled bids to borrow and offers to lend on whiteboards surrounding clusters of brokers’ desks, and you can occasionally see a broker using binoculars to read a distant whiteboard or screen – but a more crucial skill is ‘broker’s ear’: the capacity to monitor what is being said by all the other brokers at nearby desks, despite the noise and while at the same time holding a voicebox conversation with a client. As one broker put it to me: ‘When you’re on the desk you’re expected to hear everyone else’s conversations as well, because they’re all relevant to you, and if you’re on the phone speaking to someone about what’s going on in the market there could be a hot piece of information coming in with one of your colleagues that you would want to tell your clients, so you’ve got to be able to hear it coming in as you’re speaking to the person.’

When you first encounter it, broker’s ear is disconcerting. You’ll be sitting beside a broker at his desk, thinking he’s fully engaged in his conversation with you, when suddenly he’ll respond to a question or comment, from several desks away, that you simply hadn’t registered. It’s an embodied skill that affects the way Libor is calculated. The inputs to the calculation are provided daily by the money-market traders from banks that are on panels established by the British Bankers’ Association. There is one panel for each currency, and those for the main currencies each have 16 banks on them. What each bank has to provide is the rate at which it could borrow funds (‘unsecured’ – that is, backed only by the bank’s creditworthiness, not more specific collateral – and ‘governed by the laws of England and Wales’), ‘were it to do so by asking for and then accepting interbank offers in reasonable market size just prior to 11.00’ in the currency and for the time period in question.

Fascinating. One benefit of entering the New Depression is that you get to learn all this quirky knowledge about how things worked before the fall. Kind of like learning how to do a post-mortem during a post-mortem.

No comments: