The Libor Lies: Smoke and Mirror Games Continue

Well it was rally time today as the market continues to try to convince itself that the worst is behind us.

I find Wall St. fascinating because so much of it is a game of psychology. Dr. Robert Shiller from Yale describes financial bubbles as mainly being a psychological event. Bubbles tend to start with excitement and profits, are fueled by manias, and then crash in a panic. In between the cycles you will see moments of denial as the people who got in too late refuse to accept that they were the last sucker at the top. Today's housing market and tech are good examples of this.

I view the stock market right now as being more psychological in how it reacts to news versus your old school technical market. There was a time in the markets where earnings were what mattered and markets were much more predictable as a result.

Today we have a much different market. You have financial TV news networks influencing investment decisions with 100 talking heads that have 100 different opinions. Today's market also has a much larger pool of short sellers which can make the market move more violently up or down. Finally and most importantly in today's market you have the the "financial innovation" of Wall St.

This new environment makes things very confusing for the average investor because there is so much information to digest. Its gotten to the point where its almost impossible for any investor(including myself) to predict where we are heading on a short term basis. However, in the long term, fundamentals ALWAYS come back to the market and stocks are then priced appropriately to earnings. Nasdaq 5000 ring a bell?

IMO, Financial innovation's have become the most dangerous change in the financial markets because it made the stock market more vague or "shady". Wall St.'s existance is based on trust and confidence. Without trust you would have no financial system. Would you give your money to a bank that you didn't trust would pay you back?

Because we have this new financial innovation, its easier for Wall St. to "keep the game" going because they can play with the books. Level 3 asset accounting is a good example of this. Goldman Sachs has $83 billion in level 3 assets which has risen significantly from 2007. This is more then the firm has in capital. Doesn't this make them technically insolvent? Why are they allowed to not be forced to price these assets?

This game of "smoke and mirrors" took a big blow today with an article that you probably didn't hear about today. CNBC "bubbleland" TV wouldn't dare bring this to your attention. The WSJ and Bloomberg reported today that the Libor rate is being misquoted by banks. The Libor is set on the marketplace based on what the banks tell them they paid to borrow. This rate is not set by regulators. The Libor rate is set on trust.

So the banks are lying and saying they are paying a lower rate when they really paid a higher lending rate. From Bloomberg:


"The British Bankers' Association will speed up the review of the process by which money-market rates are set daily amid concern that some contributors are providing misleading quotes.
The global credit squeeze has raised concern lenders have been manipulating the so-called fixing process to prevent their borrowing costs from escalating, the Bank for International Settlements said in March. Participants have complained about whether banks are submitting accurate information, said Angela Knight, chief executive of the London-based BBA.

The association, which held its annual board meeting today, said it will ban any member deliberately misquoting lending rates.

``At the heart of the problem is that this credit crisis has crystallized why we are referencing so many securities to an uncollateralized reference rate and not a market price,'' said Francesco Garzarelli, director of macro and markets research at Goldman Sachs Group Inc. in London. ``That is why the panel is being solicited to provide better quotes. Libor is a rate that has lost some of its reference value in the current crisis.''

``The most obvious explanation for Libor being set so low is the prevailing fear of being perceived as a weak hand in this fragile market environment,'' wrote Scott Peng, head of U.S. rates strategy at Citigroup in New York."


My Take:


Well well well Wall St. just took a big step back in the trust department. We are already in a credit crisis and this will just put more fear into the marketplace. Expect the Libor rate to rise as regulators stop these "smoke and mirror" games.

Some mortgage rates are based on Libor so expect them to go up as well.

Bottom line is there will be a point where this crisis of confidence will come to a peak and its going to be ugly when it does. The tough part is figuring out when the music stops. I have a strong feeling we are very close. Wall St. knows the debt bubble has to burst and the market needs to reset with affordable housing and low inflation.

Today they just lost one of their big "smoke and mirror" instruments. The question now becomes how many tools are left in the toolbox?