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July 09, 2012

The LIBOR Scandal: Banks Dishonestly Manipulated Key Interbank Lending Rate In Order To Make Their Own Outsized Borrowing Seem Less Risky

First of all: What is LIBOR?

It’s the London interbank offered rate – or, more accurately, rates. A number of big banks submit an estimate of how much it would cost them to borrow unsecured money from another big bank for a given period of time, in a given currency. The top and bottom estimates are tossed out. The others are averaged. The resultant rates act as benchmarks for hundreds of trillions of dollars – yes, trillions with a t – of financial products, everything from complicated derivatives to simple consumer loans.

Okay, so LIBOR is an average of banks' costs on borrowed money. Since banks themselves report the figures which in turn provide the average (and that average is, in turn, used as a proxy to determine borrowers' interest rates), banks can manipulate the figure, by submitting false rates. And they could manipulate the figure if doing so would provide them with some advantage.

Which is what some banks -- including Barclays -- did.

In order to make their books appear more presentable.

There are two ways in which Barclays and other large banks could have benefited. The first is confidence. [B]ecause 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.

I believe they mean that a bank could show how healthy it was viewed by the community by claiming other banks only charged it a low rate on such loans, because they had such confidence in that bank's ability to repay. Lower rate indicates lower perceived risk.

So this is like citizens being empowered to guestimate their own credit rating -- obviously, everyone would submit better credit ratings than earned. Banks, here, were submitting false (and publicly offered) reports on their own credit-worthiness.

The second possibility...

... 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.

I have no idea how that works, but I'll trust Time Magazine to give me the straight story on the perniciousness of derivatives-traders. (Um, not really, but given that I don't understand it, I'm just repeating it without analysis.) I'll just guess that many derivatives are sensitive to small changes in such interest rates, so you could game the system by reporting a higher-than-actual rate when you needed it, and a lower-than-actual rate when you needed that, in order to benefit your own accounts.

Forbes believes that even the regulators (in England) knew banks were manipulating the rate.

That’s the heart of it: during the Crash the authorities knew that everyone was lying through their teeth about what the real Libor rate was. The reason being that the rates being reported were not including the perceived credit worthiness of some, if not all of the participants. It absolutely was a false market and Barclays were by no means the only ones falsifying it.

I suppose they permitted it because, in the depth of the crisis, they approved of some manipulation of public confidence. But that's only a put-the-best-spin-on-it guess.

Enormous lawsuits are possible:

Over the past week damning evidence has emerged, in documents detailing a settlement between Barclays and regulators in America and Britain, that employees at the bank and at several other unnamed banks tried to rig the number time and again over a period of at least five years. And worse is likely to emerge. Investigations by regulators in several countries, including Canada, America, Japan, the EU, Switzerland and Britain, are looking into allegations that LIBOR and similar rates were rigged by large numbers of banks. Corporations and lawyers, too, are examining whether they can sue Barclays or other banks for harm they have suffered. That could cost the banking industry tens of billions of dollars. “This is the banking industry’s tobacco moment,” says the chief executive of a multinational bank, referring to the lawsuits and settlements that cost America’s tobacco industry more than $200 billion in 1998. “It’s that big,” he says.

As many as 20 big banks have been named in various investigations or lawsuits alleging that LIBOR was rigged. The scandal also corrodes further what little remains of public trust in banks and those who run them.

One point, though: The first article I linked suggests that the general direction of manipulation of the rate was downwards; in that case, consumers themselves would "benefit" from artificially-low rates. Of course, to the extent that this contributed to the crisis, they were then losers, weren't they? But I don't know if you could sue for such a speculative connection between bad act and bad outcome.

But Every Winner Creates A Loser: As @comradeArthur notes, borrowers might have benefited from artificially-low rates, but savers would then be the losers; an artificially low borrowing rate means an artificially low interest rate on savings.

Which is another word for "millions upon millions of claimants."



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posted by Ace at 03:52 PM

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