Gary Gensler's criticisms of Libor miss the point.
Libor has been under attack since June last year, when Barclays was fined $450m for its manipulation of the rate. But few criticisms have been as stringent as those of Gary Gensler, the influential head of the US Commodity Futures Trading Commission.
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He said last month that Libor, a global benchmark to which perhaps $800,000bn of financial products are referenced, was “unsustainable” and should be replaced. He claimed that Libor was flawed because it was often based on banks’ estimates of the rates at which they can borrow, rather than actual trades. “I don’t now how a rate that purports to measure a market can continue when that market doesn’t exist,” he said.
But this argument misses the point about Libor. As its defenders point out, it was never intended to be based solely on real borrowing rates. The fact that it is a polled estimate, given by experts that monitor the markets daily, smooths it out in the medium term and makes it far less volatile than any traded rate would be.
Those who say Libor must be scrapped have yet to suggest a viable alternative. Most point to overnight index swaps and repurchase agreements. But these lack liquidity beyond an overnight tenor.
Simply put, there are no existing traded rates that could fulfil the role Libor plays. And it would be fanciful to think that governments or regulators could create one from scratch.
Libor is far from perfect. Even its admirers realise it is nothing more than the best of a bad bunch of options. But it should be reformed, not scrapped. Changes could include adding more banks to the Libor-setting panels and reducing the number of tenors from 15 (bankers say there is little use in having, for example, eight- and 11-month Libor rates set daily, given their irrelevance to the market).
Even more importantly, Libor’s rules should be made clearer to prevent the type of abuse that happened at Barclays and other banks, when traders wanting to bolster their positions got submitters to falsify quotes. Such reforms would help improve financial stability. Replacing Libor with a nonexistent alternative would not.
