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Tuesday, July 10, 2012
LIBOR scandal - CRIME OF THE CENTURY
DATA DRIVEN VIEWPOINT:However history judges the LIBOR rate-fixing scandal, revelations of the scope of market manipulations by corporate giants should forever lay to rest the idea that markets are naturally self-regulating or that government regulations only interfere with markets. Markets are more like a sport, such as football or soccer. Like a sport, markets only exist by virtue of the rules by which they are played. They require some physical infrastructure and there must be unbiased referees on the field as the game is being played. They also require regulatory governance off the field to monitor the leagues, to assess and refine the rules of the game and to enforce consequences when there are infractions. If governments don't do a better job of regulating the markets, if they don't hold players responsible for infractions, markets will continue to degenerate and whole economies will collapse. Those who advocate less regulation ultimately do so out of self-interest (a la Ayn Rand) which, as recent scandals have proven, is not really what is best for healthy markets.
LIBOR Scandal: The Crime of the Century?
The latest interest-rate-fixing LIBOR scandal is being heralded as the most egregious in a generation
The 21st has been a banner century for financial and accounting scandals. Enron, the dotcom bust, the subprime-mortgage crisis and the bank bailouts have all contributed to the very low esteem in which the American public holds Corporate America in general, and high finance in particular. So it is no small feat that the latest interest-rate-fixing LIBOR scandal is being heralded as the most egregious in a generation or, as Robert Scheerput itin the Nation, “the crime of the century.”
LIBOR is an acronym for the London interbank offered rate, and it is the average interest rate the world’s largest banks pay when they borrow money. And this figure (or figures, as different LIBORs are calculated for different loan maturities and currencies) is used to price hundreds of trillions of dollars worth of financial instruments, from high-yield corporate debt to student loans.
Considering the importance of this benchmark rate and the financial industry’s recent track record, it is no wonder that many in the press are up in arms about Barclays’ recent admission that it intentionally submitted false rates in order to manipulate LIBOR for its own gain. Barclays has been fined more than $450 million by British and American regulators, but it is by no means the only bank thought to have deceptively tried to influence LIBOR — thus the outrage expressed this past week in the media.
Scheer, for instance, pulled no punches in his polemic:
“Modern international bankers form a class of thieves the likes of which the world has never before seen. Or, indeed, imagined … It reveals that behind the world’s financial edifice lies a reeking cesspool of unprecedented corruption. The modern-day robber barons pillage with a destructive abandon totally unfettered by law or conscience and on a scale that is almost impossible to comprehend.”
So why did traders at Barclays submit false LIBOR figures? There are two ways in which Barclays and other large banks could have benefited. The first is confidence. Two of the safeguards built into the computation of LIBOR are that all the banks’ submissions are public, and the top and bottom four are removed from the calculation. This way no one bank can effectively raise or lower LIBOR in order to profit from prior knowledge of where the rate will be, and transparency will dissuade banks from trying.
But because of the public nature of the submissions, there is a danger that a bank will understate its LIBOR submissions in order to boost markets’ confidence in the institution. This prospect became more likely during the financial crisis, when a bank reporting high borrowing costs could have dire and perhaps fatal effects.
The more pernicious charge is that derivatives traders Barclays, along with several other as-yet-unnamed banks, colluded to influence LIBOR, not so that investors would have confidence in them, but so that they could reap profits on derivatives trades. According to a report in the Economist:
“The sums involved might have been huge. Barclays was a leading trader of these sorts of derivatives, and even relatively small moves in the final value of LIBOR could have resulted in daily profits or losses worth millions of dollars.”
The first contention, that banks were systematically understating their borrowing costs, with the tacit support — as former Barclays CEO Bob Diamond alleged in hearings last week — of the regulators, is a serious one. Those responsible for this behavior should be punished, but future incidents of such behavior could be prevented by merely reforming the way LIBOR is calculated.
The second charge is graver, because it speaks to the moral compass, or total lack thereof, of the world’s financial professionals. Much of the American public believes that financiers are greedy scoundrels who will stop at nothing — including blatant fraud — just to make a buck. This is an oversimplification. Finance is a necessary and societally beneficial industry. But scandal after scandal has proved that the industry’s culture is deeply flawed, and that it has, as the Economist put it, a “rotten heart.”
So is the LIBOR scandal the crime of the century? The full extent of it has yet to be revealed, and if it is discovered that many more banks were lying about the rates at which they were borrowing, or worse, working together to defraud the greater public through LIBOR, then it’s hard to think of a recent corporate offense that’s more troubling. But, more important, the cumulative effect of these scandals is that the public and the government no longer trust the industry to set its own standards for acceptable behavior. Diminished confidence in the financial industry by businesses and the public will retard economic growth generally. And if an industry as vital as finance is unable to police itself, then government has the right — and perhaps the responsibility — to do more policing itself. Unfortunately, the price of that increased regulation, in whatever form it takes, will be borne by all of us.
Indeed, the Federal Reserve was worried about possible Libor manipulation 14 years ago, according to Business Insider.
Barclays agreed last month to pay $450 million to settle charges that it had rigged Libor, a key interbank lending rate that is used to help set interest rates around the world. If the banks set Libor too high, then that could have raised borrowing costs for businesses, homeowners and other borrowers. Two million U.S. mortgages (largely subprime adjustable-rate mortgages) are indexed to Libor, according to research by the Federal Reserve Bank of Cleveland cited by the Washington Post.