Taking the L-I-E Out of Libor

Illustration by Ethan Buller

By Kim Schoenholtz and Lawrence J. White Jul 26, 2012 6:45 PM ET

The recent revelations by Barclays Plc (BARC) probably spell doom for the London interbank offered rate, at least in its present form.

Many banks facing huge legal risks could decide to end their participation in the rate-setting process. And even if most institutions remain involved, Libor needs fundamental reform if it is to restore its credibility as a benchmark for hundreds of trillions of dollars of financial contracts.

How to ensure that a damaging scandal won’t happen again? The answer seems straightforward: Wherever feasible, benchmarks for financial contracts should derive from actual transactions, not surveys, as is the case with Libor.

The current “survey Libor” is an old-school model that can’t endure. Each day, a group of banks -- 18 for the U.S. dollar panel -- submit to the British Bankers’ Association the hypothetical interest rate at which they believe they could borrow from other banks. To determine the rate, the BBA disregards the top four and bottom four responses, and averages the remaining 10.

Hypothetical Benchmark

In the old days, the BBA maybe could have counted on an honest answer to this hypothetical question. But the incentives for banks to lie increased as Libor became widely used as a benchmark, making it a potential means of manipulating trillions of dollars of contracts.

The global financial crisis that began in 2007 added a powerful reason for banks to lowball Libor submissions because any institution that revealed that its funding costs were higher than those of its counterparts could be putting itself at risk of a run by its fearful depositors. The now-public record of Barclay’s activities shows how such considerations can overwhelm a bank’s compliance safeguards and reputational considerations, not to mention its ethics.

Transactions (at least in large volumes) don’t lie. The deeper the market, the more difficult it is to manipulate. That is why investors confidently trade trillions of dollars in futures and options contracts based on transaction prices in liquid markets such as U.S. Treasury bonds or theStandard & Poor’s 500.

In the case of the interbank loan market, the effective rate actually paid -- weighted by the volume of transactions at each rate -- would be a natural benchmark for other financial contracts.

How could the BBA’s “survey Libor” be replaced with a transactions measure? One approach would be a clearinghouse to broker interbank loans. It would make the interbank market more efficient, and need only exist electronically, allowing banks to post fund bids and offers to counterparty banks of their choosing. It also would make it possible for willing banks to transact and settle in real time.

Much as the Federal Reserve does with the federal funds market, the Bank of England could use the anonymous transactions data from the clearinghouse to post an effective Libor rate at each active maturity. The central bank could also disclose transaction volume and information on the dispersion of interbank lending rates.

Naturally, not all maturities (or currencies) provided for by the existing Libor process would be active on a daily basis. Especially in a crisis, the volume of transactions at longer maturities can be expected to plunge, as it did in 2007-2008.

Pricing Rules

Yet making volume information available would allow the parties to Libor-linked financial contracts to agree in advance on robust pricing rules -- which would be less vulnerable to egregious manipulation -- to be implemented for illiquid maturities or episodes. The prices of exchange-traded interest- rate swaps might provide useful guides in such instances.

Continuing with the Libor status quo appears untenable. The costs paid by Barclays alone -- including a fine of 290 million pounds ($450 million) and a 24 percent plunge in its stock price since the settlement -- should be sufficient to make banks reconsider their involvement in the process. If they can no longer justify to shareholders the risks of participation, “survey Libor” will die.

Now that Barclays has settled, regulators must address the possible misbehavior of more than a dozen other Libor-panel banks. And prosecutors may still bring criminal or civil charges against banks or their employees for fraud or collusion.

The potential liabilities and risks are astounding. Aggregate penalties and fines could easily amount to billions of dollars. Lawsuits by injured parties could add billions more. In a worst-case scenario, a criminal conviction for U.S. antitrust violations as a result of Libor collusion could cost a bank its charter. If several institutions were threatened with this fate, a bank run or a broader financial crisis would be possible.

To ensure a safe and speedy Libor transition, U.K. authorities could pay the new system’s setup and initial operating costs, which are likely to be modest. Over time, the electronic clearinghouse could become a publicly owned and operated utility, or it could be sold and chartered to a strictly regulated private owner.

Like Fedwire, the platform provided by the Federal Reserve for large interbank transfers in the U.S., a new low- or no-cost service for Libor probably would attract the overwhelming share of transactions in the market. The resulting benefits of a transparent and credible Libor benchmark would far exceed the minimal cost of operating the new system.

(Kim Schoenholtz and Lawrence White are professors of economics at New York University’s Stern School of Business. The opinions expressed are their own.)

How to Break NRA’s Grip on Politics: Michael R. Bloomberg

By Michael R. Bloomberg Jul 26, 2012 6:40 PM ET

It has been a week since the massacre in Aurora, Colorado. The two major U.S. presidential candidates spent the past week avoiding the subject of whether anything should be done to prevent such shootings from recurring.

Mitt Romney, the presumptive Republican nominee, declared Wednesday that “changing the heart of the American people” is our best hope to stop the carnage. President Barack Obamaoffered little more than support for his past positions, such as banning assault weapons. Very likely, both candidates will spend the next few months avoiding the issue altogether.

Enlarge image

New York City Mayor Michael Bloomberg. Photographer: Spencer T. Tucker

The wise men of Washington tell us that candidates are silent on guns because to speak out is to incur the wrath of theNational Rifle Association. But polls consistently show that gun owners, including NRA members, overwhelmingly support the common sense measures that mayors across the country have been trying to get Washington to pass for years.

More than 700 mayors, from both political parties, have joined together to stop the flow of illegal guns into our communities. Mayors know all too well that the debate on the Second Amendment is over. The Supreme Court recognized that the Second Amendment grants citizens the right to bear arms, subject to reasonable restrictions. The question is: What should those restrictions look like?

Mayors and the NRA strongly agree that the federal government should enforce the laws already on the books. Federal law prohibits all felons -- and those with a history of mental illness or drug abuse -- from possessing guns.

The NRA believes -- rightly -- that enforcing the law means prosecuting criminals to the fullest extent. In New York state, we have increased the mandatory minimum prison sentence for illegal possession of a loaded gun to 3 1/2 years, one of the toughest penalties in the country.

But whether fighting illegal guns or drugs, we should seek not merely to make arrests, but to prevent the crime from occurring in the first place.

That is why the federal government requires licensed firearm dealers to conduct background checks to determine whether an individual is eligible to purchase a gun.

Nonlicensed sellers, however, are not required to perform federal background checks, and as much as 40 percent of gun sales slip through this loophole. Criminals and the deranged can buy guns simply by logging on to the Internet or visiting a gun show -- and they do, every day. Stopping them requires background checks for every gun sale, a change strongly supported by major law enforcement organizations, as well as gun owners and NRA members. But not theNRA’s leadership.

The NRA is a $200 million-plus-a-year lobbying juggernaut, with much of its funding coming from gun manufacturers and merchandising. More than anything, the NRA is a marketing organization, and its flagship product is fear. Gun sales jumped after Obama was elected president, based on the absurd -- and now demonstrably false -- fear that he would seek to ban guns.

There is one particular fear the NRA manufactures with great success: fear of electoral defeat. Romney has walked away from the assault-weapons ban he once supported, and in nearly four years, Obama has offered no legislation to rein in illegal guns. In Congress, the NRA threatens lawmakers who fail to do its ideological bidding, although its record in defeating candidates is much more myth than reality.

What can be done?

One of the U.S. Senate’s most pro-gun members has paradoxically shown how the battle might begin. Republican Senator Tom Coburn of Oklahoma, also the chamber’s most sincere fiscal conservative, has made it his mission to diminish the influence of another ideological group that has exercised unwarranted sway over public policy: the anti-tax absolutists led by Grover Norquist and Americans for Tax Reform.

To confront Norquist, Coburn identified an indefensible tax -- the ethanol subsidy -- isolated it and forced a vote on it. His colleagues, many of whom had signed Norquist’s pledge never to raise taxes, were forced to choose between opposing what Coburn decried as an obvious “special interest giveaway” or looking like spineless shills for Norquist. By heightening attention on the vote, the tactic worked. The $5.4 billion ethanol subsidy was voted down.

The Coburn approach could be applied to guns. Elected officials who profess to be tough on crime but who also oppose tougher measures to stop illegal guns can’t be in two places at once -- particularly when many law enforcement organizations support basic gun measures that simply don’t exist today. In the same way Coburn pointed out the ethanol-corporate welfare contradiction, a pro-gun senator can point out the obvious: It’s impossible to support police officers and law enforcement agencies and also oppose giving them the tools they need to keep guns out of the hands of dangerous people.

Some Americans view smarter, tougher gun measures as a hopeless crusade. But political environments change, especially when strong leaders build coalitions and carve new paths through seemingly settled territory. There are conservative, pro-gun rights members of Congress who understand that more can be done to keep guns away from dangerous people.

We know the special interests’ grip can be shaken; the most egregious gaps in gun regulation can be filled. The Coburn approach is proven. Who has the guts to follow it?

(Michael R. Bloomberg is mayor of New York, co-founder and co-chairman of Mayors Against Illegal Guns, and founder and majority owner of Bloomberg News parent Bloomberg LP.)

What the Public Knows about the Political Parties

Pew Research News IQ Quiz

Released: April 11, 2012

Overview

Before you read the report, test your own News IQ by taking the interactive knowledge quiz. The short quiz includes many of the questions that were included in a national poll. Participants will instantly learn how they did on the quiz in comparison with the general public as well as with people like them.
Take the Quiz

The News IQ Quiz

Most Americans can correctly identify the relative positions of the Republican and Democratic parties on the major issues of the day. But a review of what Americans know about the political parties shows that the public is better informed about the partisan affiliations of two popular recent presidents – Ronald Reagan and Bill Clinton – than it is about the positions of the parties on key issues that dominate the current national debate.



About seven-in-ten (71%) know that the Republican Party is considered to be the more conservative party. And majorities can correctly place the parties relative to each other on current issues that define the liberal-conservative divide, such as taxes, gay rights, abortion, and defense spending.
But the latest News IQ survey by the Pew Research Center for the People & the Press, conducted March 29-April 1 among 1,000 adults, finds considerable variance in what the public knows about the parties. While 67% correctly identify the Democratic Party as more supportive of raising taxes on higher-income people to reduce the budget deficit, far fewer (53%) identify the Republican Party as more in favor of reducing the size and scope of government.




While there is some confusion over theparties’ ideological and issue positions, two recent political figures are clearly identified with their respective parties. Overall, 85% of the public knows that Reagan was a Republican, while virtually the same percentage (84%) knows that Clinton is a Democrat.
Nearly as many (78%) correctly identify John F. Kennedy as a Democrat. But Americans are less familiar with the partisan affiliations of earlier presidents and current congressional leaders. Roughly six-in-ten (58%) know that Franklin Roosevelt was a Democrat, while 55% correctly identify Abraham Lincoln as a Republican. Comparable majorities know that House Minority Leader Nancy Pelosi is a Democrat (61%) and House Speaker John Boehner is a Republican (55%).
Two other items on the poll asked about the parties’ nicknames and symbols. Nearly seven-in-ten respondents (68%) correctly said that the initials “G-O-P” are usually associated with the Republican Party. And 65% correctly noted that the Democratic Party uses the donkey as its mascot or symbol.

Partisan Differences in Knowledge

Republicans fare substantially better than Democrats on several questions in the survey, as is typically the case in surveys about political knowledge. The largest gaps are in awareness of which party is more supportive of reducing the size and scope of the federal government (30 points) and which party is more conservative (28 points).
Republicans also are 21 percentage points more likely than Democrats to know that the GOP is more supportive of drilling for oil in the Arctic National Wildlife Refuge.
There is only one policy question – which party is more supportive of cutting defense spending – on which Democrats are more knowledgeable than Republicans. Two-thirds of Democrats (67%) identify the Democratic Party as being more supportive of reducing the size of the defense budget, compared with 59% of Republicans.
On the remaining issues – expanding the rights of gays and lesbians, increasing taxes on the wealthy, restricting abortion and providing immigrants who are in the U.S. illegally with a possible “path to citizenship”– there are no significant differences in knowledge between Democrats and Republicans.
Republicans also are more familiar with the partisan affiliation of two leading Democrats – one from the present, Nancy Pelosi, and one from the past, Franklin Roosevelt. Three-quarters (75%) of Republicans know that Pelosi is a Democrat, compared with 59% of Democrats. And while 73% of Republicans identify FDR as a Democrat, just 58% of Democrats do so.
Independents also are less knowledgeable than Republicans about the parties’ positions on a number of issues and the affiliation of some political leaders. Notably, independents (71%) are less likely than Republicans (85%) or Democrats (84%) to know that John F. Kennedy was a Democrat.
The partisan gaps in knowledge are at least partly a consequence of demographic differences. On average, Republicans are older and more affluent than either Democrats or independents, and both of these are associated with knowledge about the parties’ positions and leaders.

Demographic Differences in Knowledge

Although previous Pew Research surveys of political knowledge have found young people to be less knowledgeable than older people, the pattern in this poll is more mixed.
People younger than 30 are much less likely than older Americans to be able to correctly associate several political leaders with their parties. Fewer than half of those younger than 30 correctly identify Nancy Pelosi and Franklin Roosevelt as Democrats (43% each). By contrast, three quarters of those 65 and older know that Pelosi and Roosevelt are Democrats. The gap between young and old is nearly as large on the item about John F. Kennedy’s party (28 points).
But young people are relatively well informed about the parties’ positions on most issues. In fact, people younger than 30 are more likely than those 65 and older to know that the Democrats are more supportive of expanding gay rights (72% vs. 56%) and creating a way for illegal immigrants to become citizens (74% vs. 59%).
On several other issues – which party is more supportive of drilling for oil in Alaska, reducing the defense budget and for restricting access to abortion – there are no significant age differences. In addition, about seven-in-ten across all age categories, including 68% of those younger than 30, know that the Republican

  

Party is considered to be more conservative on most political issues. However, fewer than half (44%) of young people know that the Republican Party is more supportive of reducing the size and scope of the federal government; majorities in older age categories know this.
As in previous Pew Research Center News IQ surveys, there are wide educational differences in knowledge about the parties. Those with no more than a high school education are far less likely than better educated people to be aware of the parties’ positions on issues and to correctly associate political leaders with their parties.

04-11-12 Knowledge Topline for Release

We Did ‘Build That,’ and Our Government Helped

By Jonathan Alter Jul 26, 2012 6:30 PM ET

The flap over President Barack Obama’s “you didn’t build that” gaffe -- playing endlessly in TV ads and sure to be a major theme of the Republican National Convention in late August -- is at once sillier and more significant than it seems.

It’s sillier because fair-minded observers -- including neutral fact-checking referees -- agree that the president’s words are shamelessly being taken out of context. For Romney to base so much of his campaign on bogus editing is lame.

Here’s what the president actually said in Roanoke, Virginia, on July 13:Yet the uproar is significant because -- properly framed -- this election offers a stark choice between do-it-yourself libertarianism and Whig capitalism, between Ayn Rand andWarren Buffett.

“If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business -- you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet.”

Business Surrogates

Obama’s awkward “that” referred to “roads and bridges,” not businesses. But the president wasn’t at his best that day, to put it mildly. He needed to match his point about collaborative success with paeans to those he saluted in his inaugural address (and in many other speeches) as “the risk takers, the doers, the makers of things.” His failure to bring business executives into his White House and use them as surrogates means he has to handle damage control on his own, which looks bad.

But the comment -- in any context -- was hardly the insult “to every entrepreneur and every innovator in America” that Romney alleges. The Republicans who pounced on this misstep remind me of Democrats who took Romney’s “I like being able to fire people” line as proof that he enjoys laying off workers. It was no such thing, as even the Obama campaign recognized. Romney was simply referring to the consumer’s ability to fire insurance companies that provide poor service.

These gaffes don’t open a window on the values of the candidates, only on the vapidity of the process.

Still, a larger question has been left dangling: Was the president right that business has received critical help from the government over the years?

On this, the evidence is in. Alexander Hamilton’s federally chartered Bank of the United States; the Whig “internal improvements” of the early Republic; the transcontinental railroad; the land-grant colleges; the Interstate Highway System; the Internet and other government-backed transportation, communications and education endeavors aren’t just examples of “government spending” long supported by both parties. They have proved essential to the creation of thousands of small enterprises.

All major energy sources have received government help in one form or another, as have aviation, biotech, real estate and scores of other industries. Even companies that don’t get direct assistance from the federal government receive plenty of downstream benefits through the tax code.

We all should know that business can’t thrive without an educated workforce and the fair application of the rule of law. Even regulation -- the bogeyman of conservative business interests -- is a necessary condition of a stable business culture. The countries with the least regulation have the most corruption, and vice versa.

Romney may understand this but the party that he represents doesn’t.

Republican Resistance

Republicans in Congress have moved repeatedly to strip away the underpinnings of a productive business environment: When it comes to education, they favor slashing student loans and research funding for higher education; on infrastructure, they oppose many construction and transportation projects that many conservatives supported until recently; on immigration, they oppose comprehensive reform that business backs as essential to a dynamic workforce, and on transparency, they oppose the Disclose Act, which would help expose the kind of crony capitalism that rots society.

The Republican agenda is essentially a down payment on a libertarian America in all areas except defense and national security. (Representative Paul Ryan of Wisconsin, whose budget is the party’s tax-and-spending blueprint, is a longtime devotee of Ayn Rand). Anyone who doubts this should read the Ryan plan, which guts social programs for the poor to pay for another 20 percent tax cut for the rich and does nothing to balance the budget. It passed the House twice and could become law if Romney wins the White House and the Senate goes Republican.

Romney said the president’s gaffes reflected his “strange” views, and supporters such as former New Hampshire Governor John Sununu said such beliefs were “un-American.” In fact, it’s the DIY libertarians -- who deny our 223-year nexus between government and business -- who are out of sync with U.S. history.

Buffett, an Obama supporter, likes to say he’s a member of “the lucky sperm club.” He notes that if he were born under a different system, he couldn’t have been as successful.

Like it or not, our private sector has always operated with at least some indirect government help. And it’s perfectly legitimate for the president to point that out.

(Jonathan Alter is a Bloomberg View columnist and the author of “The Promise: President Obama, Year One.” The opinions expressed are his own.)