From Foreign Affairs:
“The scandal has sparked calls from politicians, including Mervyn King, the governor of the Bank of England, for stronger regulation of the world’s most powerful banks. But such proposals miss a key point: Price fixing and manipulation are illegal. They have been for a long time. So it is unlikely that saddling financial markets with legal constraints that simply double down on what is already on the books will help. A better solution would go to the heart of the problem. Regulators and market participants should set such benchmark interest rates as Libor in a way that makes them reflect movements in the market, making manipulation impossible.”
“The fundamental principle underlying floating rates is to allow the market to determine borrowing costs. Customers who borrow on a floating-rate basis, if they are sensible, and institutions that loan money on a floating-rate basis, if they are ethical, therefore expect two things from a benchmark interest rate. First, the benchmark should reflect actual conditions in the financial markets. That means no random fluctuations — money costs what it is worth. Second, the benchmark rate should not be easy to manipulate. No rational, informed borrower would borrow money at a variable rate of interest and then empower the lender to determine when and how the interest rate changed in the future.”
This is one of the best and most incisive explanations of what is wrong with the current system of averaging out interbank rates – as done via the British Bankers’ Association – and what needs to be done to avoid a repeat. Refreshingly, the article, written in the sort of publication that policymakers read, does not call for more regulation, which is definitely not what is needed.
If manipulating interest rates is (or should be) a crime, then why isn’t every central banker in the world in prison?
Correct Perry and politicians who run extortion rackets i.e. tax and debt to finance vote buying to attain the trappings of office.
Why should rates be public? How about some privacy in private enterprise.
If Brit banks, or some of them or all or most or the big three want to set a rate, or not, what of it? It’s not their fault people they didn’t ask, pegged to it.
Anyway, what’s the true price of anything anymore save what command central planners desire? Or not, or just for now but.not later, unless …
There are a lot of misconceptions flying around about this whole “Lie-bor” (to use one prominent pundit’s word) non-scandal. I’d be willing to bet that before this whole think blew up not more than one person in 100 had ever heard of LIBOR, and even now I doubt that more than that ratio understand it.
First of all, LIBOR always was (and still remains) a private figure, calculated by a trade organization of the largest banks. Neither the BOE nor the Fed has ever had anything to do with it. True, in the last decade or so it has come to have fairly wide application, as a lot of lenders began using it as a benchmark rate (for their own convenience), so perhaps a bit more rigor (and control) in its calculation is warranted now. But keep in mind that neither the organization which collects the data and calculates the LIBOR rates nor any of the participating banks has any obligation to any of those other “free-rider” users.
Second, LIBOR is calculated by canvassing the 16 largest banks in the world and asking them what their expected borrowing rate would be for a range of maturities. Few, if any, banks had actual borrowings for every one of those maturities every day, so the rate was always necessarily an estimate for many of them. Also, the actual published rate is computed by discarding the 4 highest and 4 lowest rates reported, so reported LIBOR is only the average of the middle 8. Any bank which understated or overstated its rates by much would become one of those outliers and its reported rates would have no effect at all on the published LIBOR. And if the misreported rate were so small that it still was within that middle tier, obviously it would have had very little (and likely no) effect on the published LIBOR rate.
Third, it is clear that both the BOE and the Fed knew that some banks were sytemmatically under-reporting their rates, and if they didn’t actually encourage it at least they condoned it. Remember when most of this was happening: 2008, when the markets were in utter turmoil and central banks across the globe were doing everything in their power (and some things which arguably were not within their lawful power) to create some stability and prevent utter collapse. The were throwing money at the biggest banks, buying nonliquid assets, and generally distorting the markets in massive ways. It is far from inconceivable that the central banks encouraged this behavior, as it supported their own activities.
Finally, please keep in mind that Barclay’s is accused of (and has admitted to) reporting artificially low rates. This purportedly signaled to its compatriot banks (who would have been the only ones with access to that sort of bank-level data) that their peers considered Barclay’s to be a better credit risk than was actually the case. To the extent they actually believed it, that does constitute a form of fraud. But only with respect to the other 15 largest banks (each of whom, remember, was perfectly able to set its own lending rate should Barclay’s have desired to borrow from it, regardless of what Barclay’s was saying the other banks were charging). But who was harmed by this? Certainly not all of the credit card borrowers and commercial loan borrowers whose rates were tied to LIBOR; to the extent Barclay’s under-reporting actually affected LIBOR those people actually got lower rates than would otherwise have been the case. To some extend the lending institutions whose loans were priced off LIBOR (and whose own funding sources weren’t themselves LIBOR based) may have been marginally harmed, but they chose to use this benchmark for their own convenience. Anyway, I don’t think too many people yapping about this “conspiracy” are overly concerned that banks got a little less interest income than they were entitled to. What’s important to remember here is that the general public was not injured by this and may, in fact, have benefited slightly.
All of this is a faux scandal ginned up by politicians desperate for something to distract the public from the utter shambles they’ve made of the economy. Bankers make a wonderful whipping boy, and there’s no denying that they deserve much of the opprobrium that’s being heaped upon them these days. But LIBOR is not a reasonable basis for it. It’s a thoroughly inconsequential issue in any rational economic sense.
Hey,
My ARM is LIBOR based and currently I’m paying 3 1/8 percent interest. Can’t complain. It’s an ill manipulation that does no one good, for once I benefit from the criminal activities of the elites.
Y’know, there seems to be a plausible solution available without further “regulation” involved.
Publish the ranges (real or hypothecized) of rates. Publish a “weighting” of each segment of rates in accordance with the reporting banks’ volume of use (real or propaganda) in that segment.
Publish the segments and segment rates in tiers.
Let others select which tier or tiers (or combinations or averages, etc) to use as a credit rate base.
Interest rates should be deterimined by time preference – the borrower wants the money NOW the saver is prepared to hand over the money in return for having more money (the principle plus interest) in the future.
And, of course, the risk of not getting the money back at all will lead to demand for higher interest rates from savers (the risk of infinity, not getting money back at all, streaches anyone’s time preference).
However, none of the above applies in the modern world.
There was always chearting at the margin (sometimes grandscale cheating – real boom-bust stuff) – bankers like J.P. Morgan never really just “put the savings of people to work” they also always engaged in credit expansion (lending out “money” that was never really saved) and the National Banking Acts (which insisted that the debt paper of the big Wall Street “National Banks” be accepted at par, without discounting) helped build the credit expansion bubbles that led to the busts.
BUT – the core business of a banker in the early 1900s (and even much later) was still connected to real savings – there was plenty of cheating (credit expansion to reduce interest rates – as real savers would not provide all the money that was asked for without higher interest rates), but the core business still mattered.
This is no longer really true. It was always wrong to say that there was an “idenity” between savings and borrowing (people who claimed that always deserved a punch in the face – if not a long spell in prison for fraud), but now there is hardly any connection at all.
We no longer have a financial system with terrible credit bubbles within in it.
We now have a financial system that IS the credit bubble – they are one and the same.
I can not find the words to explain how terrible that is.
But it does mean that the LIBOR concept problem is just the tip of the iceberg.
I’m assuming, Johnathan, that you mean that it’s more regulation we don’t need.
” No rational, informed borrower would borrow money at a variable rate of interest and then empower the lender to determine when and how the interest rate changed in the future.”
Um, isn’t that exactly how standard variable rate mortgages work? Doesn’t the lender get to decide the interest rate?
To distract attention from the elephant in the room – QE?
I agree with you, Laird, but I think the deception goes one step further, because the banks and the government do share a lot of personnel.
Forget the labels and the rhetoric. Look at the real groupings.
I don’t dispute the “groupings”, JohnB, I was merely saying that the LIBOR “scandal” is merely a grand distraction and in actuality is of no real significance to anyone. It’s pure show. As to QE (really off-topic here), it’s not so much the elephant in the room as the elephant’s droppings. The real elephant is the systematic and politically-motivated debasement of every currency on the planet. QE is just its latest manifestation.
Andrew, no, that’s not how standard variable-rate mortgages work. The rate adjustment is not at the discretion of the lender; it’s tied to an index which is (supposed to be, anyway) outside of the lender’s control, and the timing is specified in the contract. Of course, central banks have some ability to affect those indices, but they’re not really the lender.
“Everyone expresses, like shock and stuff that made up interest rate thing has been like, totally made up by banks.”
There was some credit crunch thing going on and nobody would lend anybody anything. So what rate are the banks supposed to say they could borrow at? One zillion squillion percent? Infinity percent?
It looks to me like Barclays were the last honest bank out there and that is why their rate stood out so they came under pressure from the BoE to fall into line with their Libor submissions.
I agree with Laird. This is a distraction at best from the horrific mess the establishment (wherever they work) have made of things.
What upset me the most about this affair is that the Bank of England felt that they had a right to put in an evening call to Agius to demand that Diamond fall on his sword. Rule of law? Due process? Very scary.
By the way a lower LIBOR rate would have an effect on the return on cash money market mutual funds, as many of these contain either asset swapped bonds or bonds with variable rates linked to LIBOR. So for savers there might have been a material impact.
But, LIBOR is an average constructed in a medianesque way (two outliers are removed, mean of bottom and top quartile taken…I think) so it is in principle impossible for an individual bank to influence the rate materially.