Markets, manipulators and the LIBOR scandal

The great thing about a free market economy is that the market is impersonal.  The rise and fall of supply and demand coordinate the activities of many people without being under the control of any one person or any group of people.  Individuals are impelled by self-interest to compete to provide goods and services of high quality or low price.

That’s how a free market economy is supposed to work, and very often it does work that way.  But when economic power is highly concentrated, what we’re told is the result of free market competition is actually the decision of specific individuals—people with names, addresses and telephone numbers.

The London Interbank Overnight Offered Rate, known at LIBOR, is the average interest rate big banks on London charge each other for overnight loans.  London is as important a financial center as New York City, maybe more important, and lenders all over the world use LIBOR as a base for setting variable interest rates.  Credit card interest rates and variable mortgage interest rates in the United States are usually set at so many percentage points above LIBOR.

It turns out that the LIBOR interest rate has been rigged for at least five years.  One big bank, Barclays, has admitted reporting rates to LIBOR that were lower than what was actually paid, and the outgoing CEO of Barclays says this was done at the request of the Bank of England, which is equivalent to the U.S. Federal Reserve.  It appears that other banks were in on it.  At least 20 banks have been named in investigations and lawsuits.  So the LIBOR rate wasn’t a market rate at all.  It was what certain individuals wanted the world to think the market rate would be.

Why would you rig the LIBOR rate?  The higher the overnight rate a bank pays, the riskier the bank’s perceived prospects.  The higher the LIBOR rate, the riskier the banks’ perception of the economy.  The purpose of falsely reporting a lower rate than the actual rate is to make the public think things are better than they are.

I’m not sure who suffered economic hardship because of the false LIBOR rate.  If credit card interest and variable mortgage interest were lower than they otherwise would have been, that would be good news for borrowers.  It would have hurt municipal and county governments with funds they were parking in short term securities—for example, money they’d raised on a bond issue for a new school or sewerage plant they hadn’t gotten around to spending yet.

If the banks had reported a falsely high LIBOR rate, that would have jacked up the returns on variable rate investments.  Who profited and who lost would have depended on who was borrowing and who was lending at any given time.

What’s at stake is the principle of the thing.  You can’t make good economic decisions based on lies.

If this scandal had happened in the United States, we would expect that (1) the financial institutions would pay fines of lesser amounts than their profits from the rigging and (2) nobody would go to jail.  It will be interesting to see if things work differently in the United Kingdom.

Click on Q&A: Barclays and bank rates for a basic summary of the LIBOR scandal by BBC News.

Click on The LIBOR scandal: The rotten heart of finance for a more detailed summary of the LIBOR scandal by The Economist, which says the LIBOR rate has been manipulated for decades.

Click on JP Morgan, Barclay’s, Other Banksters Investigated for Manipulating Electricity Markets for a report on a completely different financial scandal from Firedoglake.

Click on Why Is Nobody Freaking Out Over the LIBOR Banking Scandal? and LIBOR Banking Scandal Deepens for more about the LIBOR scandal from Matt Taibbi of Rolling Stone.

Click on Massive Furor in UK Over LIBOR Manipulation: Where’s the Outrage Here? and The Real Action in the LIBOR Scandal Was in the Derivatives Trading for more about the LIBOR scandal from Naked Capitalism.

Click on Let’s end this rotten culture that only rewards rogues for an editorial on the LIBOR scandal by The Observer in London.

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