A LIBOR Primer

by Chris Sturr | November 04, 2008

Possibly to be used in tandem with our recent piece on commercial paper. From the London Review of Books:

What’s in a Number?

Donald MacKenzie on the Importance of Libor

Judged by the amount of money directly dependent on it, the British Bankers’ Association’s London Interbank Offered Rate matters more than any other set of numbers in the world. Libor anchors contracts amounting to some $300 trillion, the equivalent of $45,000 for every human being on the planet. It’s a critical part of the infrastructure of financial markets but, like plumbing, doesn’t usually get noticed. Only a handful of economists, and no other academics, have ever looked in any detail at Libor, and even the financial press didn’t show much interest in how Libor is calculated until this spring, when there was sharp controversy over whether these crucial numbers could be trusted.

The calculation of Libor is co-ordinated by just two people, who work in an unremarkable open-plan office in London’s Docklands. I watched the process, which seemed utterly routine, a couple of years ago. Just after 11 a.m. on every weekday that’s not a bank holiday, traders at leading banks send in their estimates of the interest rates at which their banks could borrow money. They do this electronically, but sometimes the co-ordinators make a phone call to a bank that hasn’t sent in its estimates, and if the latter seem implausible–typos, for example, are fairly common–they’re checked, also with a quick call: ‘Hi there, is the Kiwi chap [provider of the estimates for borrowing New Zealand dollars] about? . . . Bit of a spread on the two month. Everyone else is coming in a good bit under that.’

A simple computer program discards the lowest quarter and highest quarter of the estimates, and calculates the average of the remainder. The result is that day’s Libor. The calculation is repeated for each of ten currencies and 15 loan durations (from overnight to 12 months), so 150 Libors are published daily: overnight sterling Libor, one-week euro Libor, one-month yen Libor, three-month US dollar Libor and so on.

It’s the back-up arrangements that tell you something about how much the calculation matters. The co-ordinators have dedicated phone lines laid into their homes so they can still work if a terrorist attack or other incident stops them reaching the office. A similarly equipped building, near the office, is kept in constant readiness, and there’s a permanently staffed back-up site in a small town around 150 miles from London (I won’t be any more precise than that). Its employees periodically work in the London office, so that they’re ready to take over if need be.

Read the rest of the article

Leave a comment

Leave a Reply

%d bloggers like this: