Unless one has been living under a rock as of late, news of the most recent banking scandal involving the manipulation of LIBOR has stretched to every corner of the MSM. Honestly, I do not understand why this story has received so much attention. Yes Bankers rigged a number. Yes some people lost money on derivatives tied to said number. Yes this is yet another nail in the coffin of public’s faith in banks. But, what has occurred in LIBOR, happens every day in the US Fixed Income markets. Namely a government body that has a monopoly on reserves, increases or decreases open market operations to ensure a rate remains at target. This institution is the US Federal Reserve.
Save for the population of hedgers and traders who may have been hurt by the rate fixing, there is always the possibility that some of us may even have benefited from it. LIBOR is used as the reference rate for many debt instruments, though it is most commonly used for floating rate mortgages. By artificially setting the rate lower, when a mortgage rate is reset it would likewise reset lower, thus producing a lower monthly interest payment. The saving might not represent a massive sum on an individual basis, but add that up across a significant number of floating rate mortgages and it could represent a substantial saving, that in turn could be used to buy goods and services and thereby increase economic growth. I do not believe that what Barclays or any of the other institutions did was right. Rigging, manipulating, or any other adjective describing their activity was decidedly and morally wrong. However given the oligopoly that is banking, it is hard to imagine LIBOR being set in any other manner than as an average of the rates of major players.
Our friend Cullen Roche at Pragmatic Capitalism has done a great job writing the article I wanted to write on this “scandal” before I could get to it. His full article can be found here.
In short the reasons you need not worry about the LIBOR fixing “scandal”
- Fed Funds Rate and LIBOR have a 99% correlation
- LIBOR is an average, if Barclays had put in much higher numbers, they would have been removed as outliers
- Banks have awful internal controls…what else is new?
I will leave you with a funny fake advertisement: