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Libor Crisis Chronology
• In the spring of 2007, Bear Stearns went bankrupt
due to catastrophic losses in their mortgage
backed securities portfolio when AAA rated
mortgage paper “failed”.
• Up until that time, AAA rated commercial paper
had NEVER failed.
• As a result of AAA rated paper “failing” – by Aug.
2007 credit markets seized up because banks
refused to extend credit – even to one another.
What is Libor?
• The term Libor stands for London Interbank
Offered Rate. Libor rates are officially set in
London each morning by a group of reference
banks appointed by the British Bankers
Association. Libor rates serve as benchmarks,
or reference rates from which commercial
loans are set. Eurodollar futures serve as
symbiotic proxy for 3 month for Libor [the cost
of a 3 month time deposit].
When Libor was first observed as
being dis-functional
Timeframe: Q3/2007
TED spread is the difference in yield
between 3 month Eurodollar Future
and 3 Month T-bill in basis points. The
Eurodollar Future is a proxy for Libor.
The rush into U.S. T-Bills was “sold to
the world as a “flight to quality” trade
So what really happened?
• In Q3/2007 the < 1 year component of J.P.
Morgan’s Interest Rate derivatives book grew
from 25.27 Trillion in notional to 32.81 Trillion
in notional – a gain of more than 7.5 Trillion in
one quarter. In Q4/2007 – the same
component of Morgan’s Interest Rate
derivatives book “recoiled” back to 24.65
• When we look at the same Quarterly Derivatives reports at
table 1: We can retrieve even more evidence as to what
Product Morgan was trading to bulge their Interest Rate
Derivatives book by 7.5 Trillion in Q3/2007.
• The “bulge” was in their OTC [over the counter] Swap book
– which grew from 50.88 Trillion in Q2/2007 to 61.53
Trillion in Q3/2007 before falling back to 53.84 Trillion in
• So the “bulk” of the add was OTC Swaps that were < 1 year
– which only stayed on Morgan’s books for 3 months.
So what exactly is a FRA?
• FRA [Forward Rate Agreements] are OTC Swap
instruments which are “bets” – between
counterparties – as to what Libor rates will be in the
future. Buying FRA’s is sometimes referred to as
“synthetic borrowing” and selling FRA’s is sometimes
referred to as “synthetic lending”.
• Because FRA’s are “bets” they require that buyer and
seller of the product EACH have credit lines for oneanother – because – in theory – one never knows
“who” is going to win the bet.
• The natural hedges for U.S. Dollar FRA trades are either
Eurodollar futures or U.S. Gov’t T-bills.
Remember back in Q3/2007 there was
a credit crisis……..
• In Q3/2007 the world was gripped by a CREDIT
CRISIS where banks would not even lend to one
another on an overnight basis. This is a matter of
highly documented historical FACT.
• So how did J.P. Morgan mange to do “TRILLIONS”
of dollars worth of FRA’s [which require CREDIT]
• Perhaps a better question is, WHO did J.P.
Morgan do TRILLIONS of FRA’s with when banking
counterparties were NOT EXTENDING CREDIT,
hence, NOT TRADING???
J.P. Morgan’s counterparty was NOT A
• J.P. Morgan was a PURCHASER of short dated
FRA’s at yields LESS THAN the those of the short
dated T-bills they purchased to hedge and lock in
• This is why, initially, 3 month T-bill rates
plummeted 200+ basis points in days while
Eurodollar futures rates stood still [reflecting
banks’ unwillingness to lend or extend credit].
• This is what “blew out” the TED spread and made
Libor appear to be “broken”.
The other side of Morgan’s trades
could only have been one
• Given that the world was gripped in a credit crisis
where NO CREDIT WAS AVAILABLE and given that
J.P. Morgan was “induced” to trade and extend
massive amounts of credit and purchase
UNTHINKABLE amounts of U.S. Government Tbills at ever decreasing yields – we can conclude
that J.P. Morgan was trading with the U.S.
Treasury itself. J.P. Morgan executed TRILLIONS
of dollars worth of FRA trades with the U.S.
Treasury’s Exchange Stabilization Fund [ESF].
The Libor Crisis was Made in America
• Any notion that the Libor crisis was the fault of
Euro-centric banks is misinformation and a
• The Libor crisis came about when banks – acting
prudently – stopped buying commercial paper or
extending credit - arising from the FAILURE OF
TRIPLE A RATED U.S. Mortgage paper.
• When the credit markets “FROZE” – the U.S.
Treasury / Fed PANICKED and forced rates to zero
to try to “thaw” the freeze.
Blame the Ratings Agencies
• If “blame” for the Libor crisis is to be put anywhere – it should be
on the U.S. ratings agencies that rated toxic sub-prime mortgage
paper as AAA.
• It was their greed and incompetence – working hand-in-hand with
TOO BIG TO FAIL U.S. BANKS that created the problem.
• The U.S. Treasury - using the New York Fed as their “broker” –
engaged in “electro shock therapy” for the global credit markets.
J.P. Morgan was FULLY aware that rates were going to ZERO and
were categorically trading with insider information, heck, they were
IMPLEMENTING U.S. Monetary policy off their trading desk.
• This is the kind of “massaging” ALL OF OUR CAPITAL MARKETS now
receive on a regular basis by U.S. Monetary Authorities.
Live by the paddle, die by the paddle

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