Much has already been written about how a substantial number of banks have manipulated and misrepresented their LIBOR submissions for their economic benefit. But thus far, the conversation surrounding the LIBOR scandal has been primarily focused on how long the scandal has been occurring, and who knew what, when. Levy Economics Institute senior scholar Jan Kregel takes a different look in a policy note, “The Libor Scandal: The Fix is in—the Bank of England Did It!” He examines why the scandal happened in the first place, and what should be learned from it.
As background, LIBOR (London Interbank Offered Rate) is an index that represents a rough estimate of the rate at which banks are able to borrow or willing to lend on a short term basis. A select group of large banks in London submit their respective rates to Thomson Reuters, which then calculates and distributes the average rate on behalf of the industry trade group, British Bankers’ Association (BBA). That rate, despite being unverified and not subject to regulatory scrutiny, is used as a benchmark for a wide array of private lending arrangements. What this means is that many consumer loans, including adjustable-rate mortgages, private student loans, and credit cards, as well as more complex financial instruments, such as derivatives contracts, are pegged to LIBOR.
Returning to Kregel’s analysis, he finds that there were really two LIBOR scandals, perpetrated at different times, in different ways, to achieve different results.
The first scandal, according to Kregel, occurred before the 2008 global financial crisis, when traders manipulated rates up or down, depending on their positions to make as much money as possible. Kregel characterizes this rate setting as motivated purely by traders’ “venal greed.”
The second scandal, according to Kregel, occurred during the global financial crisis. As banks were on the verge of calamity, there were disparities between banks’ rate submissions. Specifically, British financial regulators were concerned that Barclays’ rate submissions were higher than others’ rate submissions, and that this likely meant other banks were only willing to lend to Barclays at higher rates. This would suggest that Barclays was in trouble and might need government aid. According to the Commodity Futures Trading Commission (CFTC), to counteract regulators’ concerns as well as any market perception that the bank’s condition was deteriorating, Barclays’ senior management directed the bank’s rate submitters to lower their rate submissions to be closer to the rates submitted by other banks. Thus, Kregel argues that the second instance of rate manipulation and misrepresentation was not due to “venal greed,” but instead self-preservation efforts.
Based on Kregel’s analysis of each LIBOR scandal, we can learn two lessons. The first is that big banks will do whatever they can to make as much money as they can, even if those activities skirt the law. The second is that big banks were propped up by regulators (foreign and domestic) in more ways than was originally apparent. Based on the facts, it is very possible that British regulators were aware of—and possibly condoned or even encouraged—Barclays’ LIBOR rigging because it would provide confidence to the market during a time of immense turmoil.
While Barclays has paid for its misdeeds to the tune of $450 million in fines and some heads have rolled, the problems that caused the misrepresentations remains the same. LIBOR continues to be a poor gauge of borrowing and lending costs, and of underlying market fundamentals. Additionally, banks that pose systemic risks such as Barclays continue to exist in a form that would again make it likely that regulators will turn a blind eye to suspicious activities, if they believe it’s necessary for economic stability.