Libor: What is Wrong and What is Meh

As far is my understanding, there were two periods of Libor fixing at Barclay and elsewhere;  one prior to 2008 which involved manipulating Libor to boost trading profits indirectly and a second after 2008 where they manipulated Libor to prevent themselves going under.

First of all, disclaimer for Barclays, “they” were all at it, Barclays were just the most thorough in their investigations and the quickest in settling with various regulators. Bob Diamond’s ire is somewhat justified for that.

What Bob Diamond is not justified in doing is conflating the two sorts of Libor fixes in which banks were involved. Briefly, Libor is the London interbank offered rate, this is the average rate at which banks think they will be able to borrow large amounts of money from each other. An individual bank reporting a high Libor individually will raise doubts about its solvency. Trillions of pounds of financial products us the Libor rate as a benchmark rate for their pricing. Manipulating it even a tiny fraction hence has potentially huge ramifications.

As always in banking you have to pay attention. Prior to 2008, in the boom years, Barclays would very occasionally over-reported the rate at which they expected to be able to borrow, so it would push up the profits of their trading division. After 2008 Barclays under-reported the rate at which they expected to be able to borrow because it could have caused them to collapse.

After 2008 banks stopped lending to one another and Libor rates became a little esoteric, it was “the rate at which banks did not lend to each other.” In this period risk was mispriced but with the purpose of helping Barclays and the whole global financial system survive. This I feel is much more acceptable, and even regulatory forbearance of this fraud may be worthwhile given how damaging financial crises are.

What occurred before 2008 however was just awful. But what has to be clear is that this isn’t down to individuals, when you have simultaneous actions across a system you should blame the system.  But before 2008 it was out and out fraud and there should be criminal proceedings. After all, we live in a country where you can go to jail for stealing £3.50 worth of water.

In both cases a transfer was involved because risk was being mispriced, but after 2008 there was some public policy justification for doing so. Bob Diamond appears to be using this justification to defend the earlier practices and that I am unimpressed by.

This isn’t a case of bad apples – they were all doing it. The banking culture and system is broken and recruits for and promotes slightly psychopathic tendencies, we shouldn’t act surprised. But angry, I think acting angry is justified.

Advertisements

8 thoughts on “Libor: What is Wrong and What is Meh

  1. Oh come on. Diamond was clear that the earlier practices were unacceptable. Where I doubt his testimony regarding these is in his assertion that he didn’t know anything about them. But he certainly didn’t defend or justify them.

  2. Clear is pushing it. He has focused on the justifiable to make the unjustifiable look better. He’s tried to tie Tucker unfairly to the whole scandal through one slightly difficult to interpret comment from 2008.

  3. Sorry, did you just argue that it’s OK for major banks to commit massive, systematic fraud in order to make themselves look solvent when they’re actually not, because bank collapses are bad? I bet Fred Goodwin’s wishing he’d thought of that…

    1. Financial crises and bank collapses are bad, remember Creditanstalt?

      I’d rather the central bank fulfilled its role and lent freely at a penalty rate, but it is very difficult to organise that at times of great crisis so yeah, sometimes breaking laws can be justified.

      The law should be there but perhaps it is best to be able to break it to prevent a massive depression.

      1. Well, I have no problem with the idea that financial crises and bank collapses are bad, but I’m not convinced that allowing massive wholesale lawbreaking to avert them is any better. Doesn’t that raise something of a “moral hazard” problem? I mean, is there any other field of endeavour where fucking up badly enough gets you a free pass to recoup your loses by breaking the law? Because if there is, I want in on some of that action! It’s got to beat working for an honest living, like some kind of schmuck…

        1. This is a lengthy abstract from Brad DeLong’s blog of Kindleberger on the Bank Act, which I think is relevant. http://delong.typepad.com/sdj/2009/01/charles-kindleberger-anatomy-of-a-typical-financial-crisis.html

          Basically, I agree it presents major moral hazard problems, which is why an element of discretion is required in the work of a lender of last resort. Banks should not expect to be rescued, but in extremis they sometimes will be, even if that is against the law because the alternative is too awful.

          I’d rather finance was..different..but I’m not sure how. With finance as it is, occasionally breaking rules to prevent crises seems historically to have been necessary. I think lots of people need to be in prison and lots more individuals should have been bankrupted but saving the system seems like the best option.

          1. Yeah,but there’s a rather large difference between “being rescued” and “cooking the books”. We can debate the rights and wrongs of bailouts and so forth, but at least those are more-or-less transparent – we all know that RBS was bailed out, and by how much. This sort of shenanigans is a completely different matter, and it disturbs me to see people drawing parallels between them. It’s not a matter of recourse to the lender of last resort, and it’s not a “rescue”, it’s simply outright fraud. Comparing the two is like comparing negotiating a CVA to robbery – sure, they both get you out of the hole, but one happens in an orderly fashion and has future implications for your credit rating (thus at least partially addressing the moral hazard issue), while the other doesn’t.

            Whilst I’m sure we can all agree that bad things are sometimes necessary to save the system, I certainly don’t agree that anything that saves the system becomes acceptable. Where’s the limit on the malfeasance that could be ignored for the sake of “stability”? And just how stable is the system going to be in the long term once we do away with the notion that financial actors are at least expected to be minimally honest? To me, that looks like a rather large charge of dynamite laid under the very foundations of the whole system.

Comments are closed.