Saturday, July 14, 2012

Left Side of the Aisle #65 - Part 2

LIBOR scandal: What it is, why it matters

There's some big important news of late about which you might not have heard because it's just beginning to penetrate the US mainstream media. Some of the big newspapers - the New York Times and so on - have had some stories, but TV, from where most people get their news, doesn't seem to have paid much attention to it. It's big news around the world, but as is all too common, we don't hear about it because we're more focused on what Kate Moss is up to. So you might not have heard about this - or, if you have, you probably didn't get it explained properly because the people explaining it probably didn't really understand it themselves.

It's about something called LIBOR - the London Inter-Bank Offered (or Offer or Offering or Overnight) Rate. Each day, each of a consortium of now 18 international banks submits to the British Bankers Association, a trade group, an estimate of the interest rate at which they think their bank could borrow short-term from other banks. The association throws out the four high and the four low submissions and averages the rest to create the daily LIBOR.

It is, in other words, a measure of the interest rates that global banks charge each other for short-term borrowing, without any guarantees against default, such as those offered in the United States by the FDIC. The idea is that without such guarantees, it's a reflection of the actual market cost of such loans. It's monitored by government agencies, such as the Federal Reserve in the US and the Financial Services Authority in the UK, but it isn't regulated by anybody.

Why is LIBOR important? Because it provides the baseline for the interest rates on a variety of other loans and transactions. It directly affects around $10 trillion in loans and it's estimated by the Wall Street Journal that it indirectly affects $800 trillion in economic activity, everything from derivatives of multiple sorts down to interest received on savings accounts and paid on student loans, business loans, and adjustable-rate mortgages, all pegged to LIBOR. As a comparison, if you have a credit card with a variable rate, you've probably noticed that the rate is pegged to the US prime rate. These other transactions, and therefore their costs, are pegged to LIBOR in the same way, rising and falling with it.

So this is a big deal. It's an important number. In fact, The Economist calls it "the most important figure in finance."

And evidence is emerging that it has been manipulated by the banks for years for the benefit of - guess who - the banks.

So far, the scandal has been limited to Barclays, a big and old - 300 years old, in fact - London-based bank that just paid $453 million to US and British bank regulators. It's top executives have been forced to resign amid revelations of its traders’ emails, which give, in the words of former Labor Secretary Robert Reich, "a chilling picture" of how easily they got their colleagues to rig (or at the very least try to rig) interest rates in order to make big bucks. Because of the daily flow and flux of derivatives trading, even small changes in interest rates could turn into major amounts of cash. In 2007, for instance, the gain (or loss) that Barclays stood to make from normal moves in interest rates over any given day was $40 million. A day.

But here's the thing, and here's where the scandal starts to grow real claws: Because of the way it's calculated - remember, the four high and low estimates get tossed and the rest averaged - there is no way that Barclays on its own could have affected LIBOR enough to make a meaningful difference. Only the collusion of the other banks involved or at least a significant number of them could have allowed for that. And Wall Street - including the usual suspects such as JPMorgan Chase, Citigroup, and Bank of America - were right in there.

And in fact, over the past week-plus damning evidence has emerged out of the documents released as part of the settlement Barclays made with regulators. Those documents show that employees at the bank and at several other unnamed banks tried to rig the number repeatedly over a period of at least five years. Rigging the entire international system of finance for their own selfish short-term ends. Gee-what-a-shock.

Quoting Robert Reich again:
This is insider trading on a gigantic scale. It makes the bankers winners and the rest of us - whose money they’ve used for to make their bets - losers and chumps.
As if all that wasn't enough, there's a second, related scandal: Around 2007, when the whole rotten structure of derivatives of derivatives of derivatives was beginning to teeter like a two-foot-high stack of pennies, Barclays was submitting LIBOR figures clearly below what they should have been. That is, it was submitting interest rates that other banks would have charged them to loan money which were lower than what those other banks actually would have charged. What this did was make Barclays look less risky as a loan partner, less likely to default on its debts, that is, of better financial health, than it actually was. It was actively concealing its actual increasingly precarious financial condition. In its own defense, bank officials said they had to do this because all the other banks were doing it, and Barclays couldn't afford to be an outlier. By concealing their actual positions in this way, these banks delayed the financial collapse, but they did not prevent it. However, they did accomplish two things: They protected their bottom lines in the short term and insured the collapse would be even worse when it did hit, as it did in 2008.

There are now investigations going on in several countries, including Canada, America, Japan, the European Union, Switzerland, and Britain. The chief executive of a multinational bank said "This is the banking industry’s tobacco moment,” referring to the lawsuits and settlements that cost America’s tobacco industry more than $200 billion in 1998. It's the moment it all hits the fan.

Which has lead to some people defending the banks not just on the usual dismissive claims such as those made by the #2 person at the Bank of England that this is just a "minor scandal" and harrumphing about how that was all back then and everything is fine now, move along, nothing to see here - but on the jaw-dropping grounds that "the world cannot afford endless litigation against banks." It's too much of a threat to growth, to the world economy, to anything and everything we hold dear - we just can't afford to hold the banks responsible for their actions. Just like in 2008, just like multiple times before, we just have to suck it up, count our losses, and lick our wounds because the prospect of doing anything else is just too horrible to contemplate. It's "too big to fail" all over again; in fact, it's beyond that to "too big to challenge."

But as always, "too big to fail" should also mean "to big to exist." It's past time to just break the banks. It's time to take over the banks. Take them over not to resell them to some other set of supposedly more efficient masters but to turn them into public, nonprofit banks and credit unions. And if the banks and bankers don't like it? Tough. You've been stepping on our faces more than long enough. It's past time you got to see what the soles of our shoes look like up close.

A couple of quick footnotes to this:

Bob Diamond, the CEO of Barclays who was forced to resign, seemed shocked that he was out. An American by birth, he apparently expected to be subject to what New York Times reporter Gretchen Morgenson called "the American rules of engagement," where in the face of evidence of illegalities, top executives plead ignorance, kick out a few lower-level managers, maybe give up a bonus or two - and then ride out the storm. Regulators, if they act, just extract fines from the shareholders rather than criminal penalties from the real actors. UK regulators may have been asleep at the wheel, but once they woke up they seem a bit more interested in actually doing their jobs than our own regulators are here.

The other footnote also involved Diamond. In its settlement with regulators, Barclays accepted that its traders had manipulated rates on hundreds of occasions. Diamond retorted in a memo to staff that “on the majority of days, no requests were made at all” to manipulate the rate. Which, someone said, was rather like an adulterer saying it was all okay because he didn't cheat on his wife on most days.


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