This is one for the “every which way but loose” file.
By now you probably know all that you’ve ever wanted to know about the scandal surrounding LIBOR, the interest rate benchmark that lies underneath about $800 trillion worth of financial contracts. (If not, see this.)
The main reason that LIBOR has been manipulated in this fashion is because the process that creates it is, well, pretty dumb. From my first post on the subject, back in February:
Here’s how Libor’s calculated. Every weekday morning someone working in the treasury at one of the designated Libor banks (a seldom-changed list of 7 to 18 major institutions) gets a call and is asked something like this: “If you guys wanted to borrow some money this morning from another bank, what interest rate do you think you’d have to pay?”
The submitted figures are arranged a row, the highest few and the lowest few are removed, the rest are averaged and PRESTO! LIBOR. Banks are accused of submitting figures for LIBOR in bad faith. Instead of answering the question as truthfully as possible, they allowed their submission process to be corrupted either by
- derivatives traders who were looking to profit from a lowball or highball figure or
- politicians and senior bank executives who, in the dark days of the financial crisis, were looking to reassure everyone that there would be no more Lehman-like bank failures
In the latter case senior figures at the Bank of England and the Federal Reserve knew about it. (In addition to anyone who read the Wall Street Journal or the Financial Times, where it was directly reported.)
Investigations into this scandal are not yet finished. They are global: regulators from the US, UK, Germany, EU, Switzerland and Japan have been or are looking into it. The top 3 leaders at Barclays have been forced to resign and the firm was forced to pay almost half a billion dollars in penalties. Almost every day brings word of new potential plaintiffs who might add to the several lawsuits already working their way through US courts.
Given all this, you’d think that stories like the following (from Reuters) would be a welcome sight.
Banks reconsider Libor panels, RBS pulls out
Banks weighed up the reputational risks from an opaque benchmarking system at the center of a global rate-rigging scandal as Royal Bank of Scotland (RBS.L) pulled out of a Singapore panel setting interbank lending rates.
People at other banks also said they might seek to get out of the panels [...]. Partaking in the panels was once deemed a prestigious task, but is now tainted with the suspicion of manipulation [...]. ”Any bank that wasn’t thinking about it would be foolish,” said a person at one of the banks contributing [...].
Far from beings good news, stories like this actually demonstrate exactly why it’s so difficult to enforce real change on the Too Big to Fail Banks. In fact, they are bigger than ever and we are just as dependent on them now as we ever were, if not more so.
It’s very simple. Yes, the LIBOR process seems like something that Bernie Madoff might have dreamt up. Yes, it should be replaced by a mechanism based on actual transactions, instead of best guesses. And yes, it should be audited, double-checked and verified for truthfulness five ways from Sunday. But what happens to the $800 trillion in LIBOR-linked derivatives, adjustable mortgages, corporate loans, credit card agreements, student loans, auto loans, variable-rate investments and USD-denominated foreign bank accounts — $360 trillion of which have a daily reset — in the meantime? What happens to all of these agreements if all of the LIBOR panel banks decided to drop out?
You don’t wanna know. And neither does the FSA, the lead UK banking regulator, who is already making contingency plans should LIBOR collapse.
And that, ladies and gentlemen, is a perfect illustration of why the Too-Interconnected-to-Fail Banks continue to hold the ultimate trump card and why this power dynamic is unlikely to change any time soon.