Seeing the ‘Lie’ in Libor

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I don’t know about you, but if push came to shove, I don’t know that I could nail down all the damage of the Libor scandal with absolute certainty.

It’s not like I don’t care about scandals, I do.  I just have a hard time with this one…but let’s see if we can’t figure a few things out.

Here’s what I know:  The Libor interest rate is the London Inter-Bank Offer Rate, which is the short-term interest rate—more precisely, the average of many rates-- that 17 or 18 banks, mainly in London, charge each other to borrow from each other.  Only a few US banks participate in the Libor index; those being Citibank, JP Morgan-Chase, and perhaps one or two others.  The Libor also happens to be the world’s benchmark interest rate, so it’s a pretty big deal to manipulate it.

Because it’s short-term, the Libor interest rate is usually more volatile, or at least more reactive, to changes in interest rates.  The Libor is a key interest rate because it is the basis for many interest rates that we pay, which means that trillions of dollars were affected by the scandal…

For instance, many adjustable rate mortgages (ARMs) are based on the Libor index, as are many credit card rates.  My old adjustable mortgage was Libor plus a 2.5% spread, for example.   As the Libor stayed low, so did my mortgage.

Big banks at it again

The Libor scandal is really about the fact that banks—big, important banks manipulated the rate, that is, kept it artificially low, from at least 2005 onward, and maybe artificially higher at an earlier time.

Okay…so what?  Millions of people—perhaps even hundreds of millions of people-- got to borrow money at a lower interest rate.  Is that bad?  Not that I can say for sure, although I can say for certainty that low interest rates hurts savers and those on fixed income who rely on interest payment for their living expenses got hurt.

That is not inconsequential, but neither is it the kind of scandal that is in the least bit sexy or notorious.  As far as scandals go, it’s a bit on the boring side, don’t you think?  So why would banks manipulate the Libor?

Well…from a balance sheet perspective, banks earn money from interest charged, and ‘lose’ money from interest paid.  If banks can under-report interest paid on borrowed money, that would make their balance sheets look better than they actually were, right?

On the other side of the ledger, under-reported interest earned on “lower interest rates” means under-reported earnings, which means less earnings are paid out to share holders.

This would mean that banks both look healthier than they really were, but at the same time, pay shareholders less than they should with regard to interest earned.  On trillions of dollars worldwide, we’re talking about some big money.

Who are the shareholders?  Other banks, financial institutions like hedge funds, mutual funds, pension funds, you know, places where everyday people invest their money for retirement.  Yes, there it is…the banks sticking it to you-know-who again.  You may not have felt it because it was spread over so much money over a long period of time, but it was there.

Same old story, isn’t it?  The banks win, you lose.  The banks lose…they still win.

But aside from that dismal fact, if we forget about the diffuse impact of the rate fixing for a moment and look at not the effect, but who is involved, it gets a little juicier…

With the Fed’s blessing

Because it’s not just the major banks in London and the US that were involved in the rate fixing, it was done with the knowledge and at least tacit approval of none other than…the Federal Reserve.  That would include one Tim Geithner, President of the New York Federal Reserve Bank at the time and our current Treasury Secretary, among others. That makes the Fed a fully involved accomplice to the crime and therefore, a central part of the scandal.

Ah, now that is a bit more exciting—or at least damning—don’t you think?

So what do we have?  We have a Libor interest rate that was manipulated, one way or another, for years, by major banks in the world with the full knowledge of the Federal Reserve.

Given that the Fed was already secretly bailing out banks as early as 2006 with hundred of billions of dollars that it did not report, it’s not a stretch to think that banks were already in trouble a year earlier than that, is it?  It’s the old equation of what did the Fed know, and when did it know it?  With the added bonus of, “and how much of a cover up did the Fed do and how much money did it spend?”

Not to worry, it’s all done in the interest of the system that we all know and love.  Are you feeling the love now?  I know I’m feeling it…

It’s warm and wet, and has a familiar-yet-offensive odor to it.

But there is also another angle to the scandal.

You can bet your bottom Federal Reserve Note that if banks are manipulating a rate, then they will make money from it any way they can...and not just to make their balance sheets look better.

A simplified but still relevant example might be if the actual Libor rate is X, and you fix it to something less than X, then there is a spread there that you can make money from on a predictable and regular basis in the money markets themselves.  Using highly leveraged derivatives on even small rate spreads can be very lucrative.    Barclays has admitted doing so, and will pay a half-billion dollar fine.

But if you’re making say, $40 million a day year after year on a rate you control, who cares?  This is especially doable when you have the largest private banks in the world looking over your shoulder and nodding in approval.

So what is the Libor scandal really about?  As it turns out, it’s not so difficult after all…

It’s all about understanding...

Understanding how the foundations of our financial system are not solid foundations at all, but rather, are movable pieces on a board game where even the board itself is not a fixed playing field…

And understanding that the entire system is a game, and that the game is best played with lies…

Of course, Mr. Geithner and whoever else may or may not be paraded before Congress will certainly persuade us otherwise, won’t he?

And those are…The Gorrie Details.

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2 Comments

1. 

   NOAH

   July 26, 2012 at 9:05 am

   Thank you, Mr. Gorrie for making the LIBOR manipulation so easy to understand!
   We should not find it surprising that, once again, the Big Banks have been discovered to have engaged in financial obsification and manipulative theft! And, once again, it is the little people that suffer the consequences most harshly. It is a wonder to me that anyone can say they have any faith at all in our Banking system...and since they now control the real estate recovery timeline, we are in even deeper s_ _t! The Banks continue to earn our disgust!

   Reply
   • 

     James R. Gorrie

     July 27, 2012 at 1:58 pm

     You're welcome, Noah. Thanks for saving all the animals...

     JRG

     Reply