How The LIBOR Scandal Affects You

The Barclays rate-rigging scandal is sending shockwaves through world finance, putting ethics and regulation under scrutiny, and raising the prospect of criminal charges in a sector-wide global probe.

Britain’s Serious Fraud Office said Friday it will investigate the interbank rate manipulation scandal which has engulfed Barclays, forced three top resignations, tainted the City of London and sparked a political firestorm.

Barclays was fined £290 million ($452 million, 360 million euros) by British and US regulators just over one week ago, for attempted manipulation of Libor and Euribor interbank interest rates between 2005 and 2009.

Barclays became the first bank to be fined as part of a global probe into suspected manipulation of the twin interest rates that are crucial to the operation of short-term financing and global markets.

British lawmakers voted on Thursday to hold a parliamentary investigation into the scandal, instead of a full judicial inquiry.

“This is a multi-bank issue — albeit evidence and fines for other culpable banks will probably dribble out over a period of many months or years,” said Ian Gordon, banking sector analyst at Investec.

“In broad terms, the issue itself and the associated fallout are damaging for the financial sector, both in reputational terms, the costs of investigation and fines — and any potential redress.

“Moreover, the issue helps to distract from and hence damage any initiatives to increase the flow of lending to the economy, with obvious negative consequences,” Gordon said.

BNP Paribas analysts agreed that the crisis had the potential to engulf other lenders.

“As far as we are aware, the regulators have so far not disclosed a full list of banks being investigated,” they said in a research note to clients.

They added that “additional fines … cannot be ruled out, although it’s impossible to assess the exact exposures”.

Libor (London Interbank Offered Rate) is a flagship instrument used all over the world, affecting what banks, businesses and individuals pay to borrow money. Euribor is the eurozone equivalent.

The Libor rate is calculated daily by data provider Thomson Reuters, on behalf of industry body the British Bankers’ Association, using estimates from banks of their own binterbank rates.

Euribor is provided by the Brussels-based European Banking Federation, using data from 43 international banks.

Barclays has admitted that its traders had routinely submitted false readings, as they attempted to benefit their own lucrative derivatives deals.

The lender also posted lower Libor values from 2008 to prevent speculation that it would require a government bailout such as rival groups Lloyds and the Royal Bank of Scotland.

“Barclays attempted to manipulate and made false reports concerning two global benchmark interest rates, Libor and Euribor, on numerous occasions and sometimes on a daily basis over a four-year period, commencing as early as 2005,” the Commodity Futures Trading Commission (CFTC) said on June 27.

The US watchdog added that employees at Barclays and its investment bank arm Barclays Capital had sought to boost trading positions to increase profits or minimise losses.

“In addition, the attempts to manipulate included Barclays’ traders asking other banks to assist in manipulating Euribor, as well as Barclays aiding attempts by other banks to manipulate US Dollar Libor and Euribor.”

Dan Wilsher, senior law lecturer at the City Law School, City University London, told AFP that the scandal raised serious questions over the conduct of some financial sector workers.

“The Libor scandal reveals a lack of honesty amongst dozens of employees — not just at Barclays — when the financial rewards are so big for cheating the system, the chances of getting caught slim and the pressure from management is very great,” Wilsher said.

“The government will try to make it a crime to give wrong Libor figures but that will be a small step.

“We have not had a broad enquiry into the ‘culture’ of banking. At the moment the Leveson inquiry is looking at the ethics of the press following numerous scandals. People say we need the same for banking.”

The government-appointed Independent Commission on Banking ruled last year that British banks should separate their retail and investment arms to avoid a repeat of the global financial crisis, blamed in part on highly speculative trading practices.

The ICB also recommended that banks substantially increase their capital buffers.

“We have just completed a big ICB review, whose findings the government largely accepted and will pass laws to implement,” Wilsher noted.

“This was a technical report on how to protect taxpayers and avoid another crash like that of 2008. It did not address the wider culture in detail but there are many different actions on this front.

“The EU restrictions on bonus payments are an important step in this direction. These need to be adopted globally. The US has introduced bans on trading activities by banks.

“Most importantly, banks need to hold much more capital and become much more risk averse. Hedge funds should take the risks and bear the consequences, not taxpayers.”

‘The mob learned from Wall Street’: Eliot Spitzer on the ‘cartel-style corruption’ behind Libor scam

Big Banks Are Rotten to the Core

Among other things, the Libor scandal is the largest insider trading scandal of all time.

It also shows that the big banks are literally rotten to the core. And see this.

UC Berkeley economics professor and former Secretary of Labor – Robert Reich – explains today:

What’s the most basic service banks provide? Borrow money and lend it out. You put your savings in a bank to hold in trust, and the bank agrees to pay you interest on it. Or you borrow money from the bank and you agree to pay the bank interest.

How is this interest rate determined? We trust that the banking system is setting today’s rate based on its best guess about the future worth of the money. And we assume that guess is based, in turn, on the cumulative market predictions of countless lenders and borrowers all over the world about the future supply and demand for the dough.

But suppose our assumption is wrong. Suppose the bankers are manipulating the interest rate so they can place bets with the money you lend or repay them – bets that will pay off big for them because they have inside information on what the market is really predicting, which they’re not sharing with you.

That would be a mammoth violation of public trust. And it would amount to a rip-off of almost cosmic proportion – trillions of dollars that you and I and other average people would otherwise have received or saved on our lending and borrowing that have been going instead to the bankers. It would make the other abuses of trust we’ve witnessed look like child’s play by comparison.

Sad to say, there’s reason to believe this has been going on, or something very much like it. This is what the emerging scandal over “Libor” (short for “London interbank offered rate”) is all about.

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This is insider trading on a gigantic scale. It makes the bankers winners and the rest of us – whose money they’ve used for to make their bets – losers and chumps.

The fact that the big banks have committed insider trading on their core function – setting rates based upon market demand for loans – is particularly damning given that traditional deposits and loans have become such a small part of their business.  As we noted last week:

• The big banks no longer do very much traditional banking. Most of their business is from financial speculation. For example, less than 10% of Bank of America’s assets come from traditional banking deposits. Instead, they are mainly engaged in financial speculation and derivatives. (and see this)

• The big banks have slashed lending since they were bailed out by taxpayers … while smaller banks have increased lending. See this, this and this

• A huge portion of the banks’ profits comes from taxpayer bailouts. For example, 77% of JP Morgan’s net income comes from taxpayer subsidies

And Libor isn’t the only way in which the banks trade on inside information.  As Robert D. Auerbach – an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and nowy Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin – points out:

Billions of dollars can be made from inside information leaks from the Fed’s monetary policy operations. One necessary step to stop leaks is to severely limit inside information on future Fed policy to a few Fed employees.

This has not happened. Congress received information in 1997 that non-Federal Reserve employees attended Federal Reserve meetings where inside information was discussed. Banking Committee Chairman/Ranking Member Henry B. Gonzalez (D, Texas) and Congressmen Maurice Hinchey (D, New York) asked Fed Chairman Alan Greenspan about the apparent leak of discount rate information. Greenspan admitted that non-Fed people including “central bankers from Bulgaria, China, the Czech Republic, Hungary, Poland, Romania and Russia” had attended Federal Reserve meetings where the Fed’s future interest rate policy was discussed. Greenspan’s letter (4/25/1997) contained a 23-page enclosure listing hundreds of employees at the Board of Governors in Washington, D.C. and in the Federal Reserve Banks around the country who have access to at least some inside Fed policy information.

Senator Sanders also noted last October:

A new audit of the Federal Reserve released today detailed widespread conflicts of interest involving directors of its regional banks.

“The most powerful entity in the United States is riddled with conflicts of interest,” Sen. Bernie Sanders (I-Vt.) said after reviewing the Government Accountability Office report. The study required by a Sanders Amendment to last year’s Wall Street reform law examined Fed practices never before subjected to such independent, expert scrutiny.

The GAO detailed instance after instance of top executives of corporations and financial institutions using their influence as Federal Reserve directors to financially benefit their firms, and, in at least one instance, themselves. “Clearly it is unacceptable for so few people to wield so much unchecked power,” Sanders said. “Not only do they run the banks, they run the institutions that regulate the banks.”

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The corporate affiliations of Fed directors from such banking and industry giants as General Electric, JP Morgan Chase, and Lehman Brothers pose “reputational risks” to the Federal Reserve System, the report said. Giving the banking industry the power to both elect and serve as Fed directors creates “an appearance of a conflict of interest,” the report added.

The 108-page report found that at least 18 specific current and former Fed board members were affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis.

[T]here are no restrictions in Fed rules on directors communicating concerns about their respective banks to the staff of the Federal Reserve. It also said many directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. The rules, which the Fed has kept secret, let directors tied to banks participate in decisions involving how much interest to charge financial institutions and how much credit to provide healthy banks and institutions in “hazardous” condition. Even when situations arise that run afoul of Fed’s conflict rules and waivers are granted, the GAO said the waivers are kept hidden from the public.

Whether you want to call it crony capitalism, socialism or fascism, one thing is for sure … this ain’t capitalism.