Hard Libor

The Libor may be one of the most important financial market statistics you’ve never heard of

By Jared Bernstein

Published July 3, 2012 2:05PM (EDT)

This originally appeared on Jared Bernstein's blog, On the Economy.

Did some TV this afternoon on the resignation of the chairman of Barclays Bank as a result of a rate-rigging scandal around the Libor, a key interest rate estimated daily by the London banking sector.

The Libor may be one of the most important financial market statistics you’ve never heard of.  It’s the rate at which banks trade with each other, but it’s come to be used as a benchmark interest rate on literally trillions of dollars of financial instruments—everything from derivatives, like interest rate swaps, to US mortgages.

For years, there’s been suspicion that the Libor was being manipulated by the banks that set it each day.  Now, according to the NYT, regulators released evidence supporting those suspicions:

Authorities found that employees in the bank’s treasury department, which helped set Libor, submitted artificially low figures at the request of the firm’s traders, who profited from buying and selling financial products. The two sides are supposed to be divided by so-called Chinese walls to ensure that confidential information is not improperly shared to make profits.

But e-mails showed that the two divisions regularly collaborated in an effort to bolster their profits and avoid scrutiny about the bank’s health at the height of the financial crisis.

[BTW, the British regulator in this case is apparently the Serious Fraud Office, which led us at OTE to wonder what the Frivolous Fraud Office is up to.  (h/t: GL)]

What Martin Bashir wanted to know just now was this: how is it that politicians running for office today can say with a straight face that they’ll repeal financial market regulation—Dodd/Frank—so as to release these “job creators” from the terrible chains that bind them?  And in fact, repealing D/F remains a key plank in Gov Romney’s campaign.

There’s no suitable answer to that question.  Anyone who’s paying any attention should be more convinced than ever of underlying instability of financial markets and thus the need for regulatory oversight.  And the fact that bankers and their political representatives would fight back has been known literally since Adam (Smith, of course):

Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But these exertions of the natural liberty of a few individuals, which might endanger the security of the whole society are, and ought to be, restrained by the laws of all governments…The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.

Note that he’s talking about the same kind of “party”/firewalls that were violated in the Barclays case.

And note that this time around—unlike after the Great Depression—the folks that blew things up are not slinking away.  They’re asserting that they were right all along and should again be allowed to self-regulate.  And their allies in Congress are right there with them.

Update: See this NYT editorial out this AM on this.  As I note below, the way this worked, traders in the bank asked the folks responsible for setting the Libor to tweak it for them.

“Always happy to help,” one employee wrote in an e-mail after being asked to submit false information. “If you know how to keep a secret, I’ll bring you in on it,” wrote a Barclays trader to a trader at another bank, referring to an attempt to align their strategies for mutual gain.

If that’s not conspiracy and price-fixing, what is?

See also Felix Salmon, who posts a revealing chart showing how out of whack Barclay’s reported interest rates were relative to the others in the daily Libor survey.  The implication here is that this shouldn’t have been hard for regulators to nail were they awake at the wheel…I mean, journalists were writing articles about this years ago (it was also crack journalism that first wrote about the London Whale, btw, the trader who lost all that loot for JPMC).   Must we replace the regulators with some young, hungry muckrakers from BBerg and the WSJ?…I’m for it.

Jared Bernstein

Jared Bernstein joined the Center on Budget and Policy Priorities in May 2011 as a Senior Fellow. From 2009 to 2011, Bernstein was the Chief Economist and Economic Adviser to Vice President Joe Biden. Follow his work via Twitter at @econjared and @centeronbudget.

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