THE MANIPULATION OF THE LIBOR

Translated from the French by Tim Gupwell

In my Friday morning video (in French), I said that when a pirate (Rupert Murdoch) does business with a ship wrecker (the City of London), it tends to weaken the entire system, and I went on to add that this is particularly the case when the population, which is observing all this from afar, starts to exhibit a certain degree of indignation.

The LIBOR affair has been widely discussed for several days now, due to the 290 million pound fine imposed on the British bank Barclays. My reaction hitherto has been limited to referring back to two articles which I wrote in 2008 at the moment when the story first broke L’affaire du LIBOR  (the LIBOR affair) , published on the 17th April, and LIBOR II ou mauvaise nouvelle pour les subprimes (Libor II or bad news for subprimes), published on the 20th April.

The proof that there has been an evolution in the way the facts are appreciated by the population – still known as ‘public opinion’ – is the fact that what had merely led to raised eyebrows in the spring of 2008 is now rocking the very foundations of the City itself.

To sum up for those who do not intend to re-read my previous two articles: the LIBOR with different maturities ( terms of 3 months, 6 months, 1 year etc) is the interbank rate practiced in London ( the rate at which the banks lend to each other), and is denominated in dollars. It is determined in the following manner: 16 banks in the City are asked to state what rate the other financial establishments charged them for borrowing on the previous trading day. To prevent the figure being fraudulently manipulated, the British Bankers’ Association (BBA) classifies the figures cited from the lowest to the highest, and then ignores the four weakest and the four strongest values, determining the average from the remaining eight.

As I said in my first article (in French), “at a stretch, [the system] can remain reliable even if up to 50% of the parties are not telling the truth. Of course, if nobody trusts anyone anymore, it will be in everyone’s interest to lie, and the published LIBOR rates will be meaningless”.

A news article published in the Wall Street Journal on the19th April led me to conclude in the second article, (in French), “therefore it seems perfectly clear: they were all lying”.

Why would a bank want to cheat? Because it has a vested interest in cheating, and what is worse, virtually everyone, and even more so the general population, has a vested interest in them doing so.

Why would it be in a bank’s interest to lie when it is asked what rate it is charged by the other financial establishments for loans? Because its very existence depends on it; if it tells the truth, its very existence can be threatened. Consequently, we can ask whether asking this question is indeed the best means of obtaining an authentic piece of information. Evidently not; quite the contrary in fact: it is the best means of obtaining a false piece of information.

Included in the interest rate a bank is charged by its lenders is the risk premium that the lender judges necessary to protect it against the risk of default. This signifies that if a bank honestly answers what rates it is charged, it is forced to reveal the poor esteem in which it is held by its peers. This is the reason I mentioned a friend in my second article in 2008 who wondered “why the banks are not asked what rates they charge to lend to others, rather than what rates others charge them?”

If a bank is in difficulty, it has every incentive to conceal this because as soon as the danger is perceived, its rivals are going to bet on its downfall. Why? Because finance is not charity; if there is money to be made, they make it. They do this by using naked positions on Credit-default Swaps (CDS); bets are placed on the collapse of the weakest one. There is no room for sentiment.

As a result, in a crisis situation, each bank will cite a rate lower than the actual figure it is charged; each one will claim that the others are lending to it at lower rates because it is credit worthy. As I wrote in LIBOR II ou mauvaise nouvelle pour les subprimes, (Libor II or bad news for subprimes), “….by manipulating the figures, everyone is trying to conceal how hard they are finding it to finance themselves; in other words, they are trying to hide the precariousness of their situation”

Therefore, it is not even necessary for the banks to agree to conceal the real numbers amongst themselves: it is in the interest of every one of them to manipulate the figures.

The question which now needs to be asked is whether it is a problem for the financial system as a whole if each bank deliberately underreports the rates that others charge them?

The answer is no, quite the contrary, and I will now explain why.

By understating the amount of the rate it is charged by lenders, each bank has helped to present a more positive image of itself than would have realistically been justified otherwise, and also a far calmer image of the capital markets as a whole than would have been the case were the real truth known. And since a considerable number of loans were indexed on the LIBOR, the borrowers concerned benefited as well. In other words, everyone was benefiting from the fact that the lies of the various parties helped to create a far rosier image than the circumstances seemed to indicate in reality.

I wrote in 2008 in my second article about the LIBOR, “The rate for mortage loans in the United States is indexed on the 6 month LIBOR ‘2/28 Adjustable Rate Mortgage (ARM)’, better known under the name subprime

Thus, for as long as an ‘unrealistically’ low LIBOR prevailed, the effects of the crisis were mitigated.

When the authorities required the banks to tell the truth; to reveal the genuine rate at which their peers were lending to them, the 6 month LIBOR immediately shot up 0.33%, which helped nobody whatsoever, and on the contrary, led to a further degradation of the situation.

All this signifies, paradoxically perhaps, that by lying shamelessly, the financial establishments helped to save the system as a whole. Not that this was their real objective; it was merely an unintended by-product. After all this was finance, not the realm of intellectuals or geeks, but that of traders, which meant that if they didn’t understand exactly how it worked, but they had the feeling that it could pay, they wasted no time on reflection and eagerly carried on regardless.

Now the authorities have reacted, and Barclays has been the first to pay the price. But as I had already explained in April 2008, the 16 involved “were all lying” in reality, and so this is by no means over yet.

That said, by maintaining artificially low LIBOR rates, the banks’ deceptive practices have helped to mitigate the effects of the crisis in the larger scale of things; and for the banks themselves, they have minimized the risk of falling prey to the bloodthirsty speculators who were hoping to precipitate their downfall.

So, in this particular case, it would have been better for the regulators (this is not something I generally advocate), to turn a blind eye, since Adam Smith’s “invisible hand” had for once genuinely manifested itself. By pursuing their own narrow self-interests, the banks had involuntarily contributed to the general good.

But with the people/public opinion now in something of a frenzy, an example had to be made of them and Barclays was the first to be punished; it was to be its 359 million Euros fines which would make the front pages.

Why a fine rather than any other type of punishment? Firstly, because money is the thing which costs the banks the least, primarily because they make lots of it and because what can seem a considerable sum to the general public is often peanuts to them, having the capacity as they do to pass their losses on to their clients or investors; secondly, because not only are they too big to fail, but also they are too big to be interrupted (too big for it to be possible to stop even the activities in which they have behaved disgracefully); and finally, by virtue of the fact that with the financial sector having provided financial support for electoral campaigns in return for the decriminalization of financial misdemeanours, it is donkeys’ years since any bankers have actually been arrested for their crimes. At worst, they have had their wrists slapped, like Mr. Diamond, the chief executive of Barclays, who having been paid 15 million Pounds ( 18.6 million Euros) in 2011 – declared that he would forego his bonus for 2012. The people, astounded by so much generosity on his behalf, bowed down immediately to thank the Lord, while the inaction of the regulators seemed to demonstrate that they were convinced that his palpable sense of remorse was punishment enough.

Oh yes! Just a little remark to finish offt. Do you remember the article on The network of global corporate control, by Stefano Battiston and his colleagues, in which it is explained that the world is controlled by 147 companies with tightly-knit interests? In the list of the top 50, guess where Barclays is to be found? You guessed it! Yes it really is the N°1! (See here, Page 33)

3 thoughts on “THE MANIPULATION OF THE LIBOR

  1. I wish to express my indebtedness to you for your enlightening post on the manipulation of LIBOR, upon which I have relied in two posts at my website:

    http://tinyurl.com/bvf99b8

    http://tinyurl.com/c7eprw9

    (I should perhaps mention for the benefit of anyone wishing to consult them that, as I began preparing them before your English-language version appeared here, I have used my own translation in my first post and taken account of Mr Gupwell’s admirable translation in the second post.)

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