Libor Lessons

The following is reprinted from last Sunday’s Kelly Letter:

The London Interbank Offered Rate, or Libor, is a benchmark interest rate that measures how much banks pay to borrow from each other. It’s used to calculate hundreds of trillions of dollars in global financial contracts, including some you might hold such as mortgages and corporate loans. What a shock to discover that banks submitted false data for purposes of calculating Libor during the financial crisis to boost their trading profits and hide their balance sheet problems. The first bank caught in the unfolding scandal was Barclays (BCS $10), the second-largest bank in Britain and one of the biggest in the world.

Documents from the Fed and elsewhere indicate that Barclays’s New York traders and its officials in charge of submitting honest data to the Libor calculating committee regularly changed the data to improve profits. It was such a normal part of their day that they didn’t even attempt to hide the collusion. One email showed a reply from an official to a trader reading, “Always happy to help, leave it with me, Sir.” Separately, one trader wrote to a colleague who helped him out, “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.” Witness the refined personalities inhabiting the world’s largest banks.

In shame — albeit mock shame, no doubt — Barclays agreed to pay $450M in fines to avoid prosecution, and its CEO, Bob Diamond, resigned with the statement that he was “deeply disappointed that the impression created by the events announced last week about what Barclays and its people stand for could not be further from the truth.” Except that it’s precisely true. Barclays admitted submitting lower than actual figures on its interbank borrowing in 2008.

Even worse, the New York Fed — then under the leadership of current Treasury Secretary Tim Geithner — and the Bank of England knew of the Libor manipulations but did not disclose them. As if you needed it, this is yet more evidence of what Charles Gasparino called in Wednesday’s New York Post “the cozy, corrosive relationship between the nation’s big banks and the bureaucrats who are supposed to regulate them.”

Gasparino pointed out that Geithner was a rotten regulator who let the banks under his jurisdiction “get away with the financial equivalent of murder, letting them take on the astronomical amounts of risk that ultimately blew up the system in 2008. And then, when they needed a bailout, he was there with a plan that made sure their banks and jobs were safe.” Too bad President Obama anointed him to become head of the Treasury. Are you surprised that nothing ever changes?

Analysts are concerned that the fraud could create a crisis of confidence and a systemically damaging raft of lawsuits. Peter Jukes wrote in The Daily Beast on Wednesday: “Paradoxically, current attempts to clean up the shadow banking system could actually make things worse. The G-20 countries are determined to force derivatives into central clearing houses where they can be properly valued. ‘But there is no good way to police whether derivative or other synthetic instruments are being priced or not,’ a former central banker told The Daily Beast. ‘These valuations are then the basis for a margin call that can move real money from losers to gainers,’ he says. ‘And the power to margin is the power to destroy.'”

On the lawsuit side, the numbers proposed are so huge that they could paralyze the financial system as plaintiffs ranging from investment companies to local governments that bought bonds pegged to Libor demand compensation from banks that deliberately held down the benchmark rate. Bloomberg: “If Libor was understated by an average of only 0.1 percentage point for a year, the discrepancy on the roughly $300T in interest-rate swaps outstanding at the time would add up to $300B. That’s about a fifth of the aggregate capital of the 16 banks whose reports were used to calculate Libor in 2008. . . . It’s certainly the last thing a struggling global economy needs.”

The Bloomberg View editors concluded on Friday: “The Libor scandal offers a sad illustration of the moral bankruptcy that has infected some corners of finance. If the response fails to demonstrate a clear break from the past, the repercussions could again inflict a lot of pain on millions of innocent people. This time, the financial sector has little goodwill to spare.”

True, but seasoned financial players know that there will be no clear break from the past when it comes to banking shenanigans. Not now, not ever.

Also in the letter:

The International Labour Organization on where the eurozone is headed.

Unit labor costs in China.

AMD’s revenue miss, and whether it’s a bargain.

The effect of Fed stimulus on stocks.

Odds on QE3.

And more! Sign up to read the rest of this letter and all back letters, and receive future letters starting this Sunday.

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  1. Pedro
    Posted July 21, 2012 at 1:15 am | Permalink

    This is no surprise is it? It does confirm a lot of the dynamics that are talked about in “Thrive” the movie. It is just the beginning. There is no sustainability in the present system. It all will have to change.

    Thanks for the letter Jason. Cheers!

    • Posted July 21, 2012 at 9:40 am | Permalink

      I agree, Pedro, that it should change but I don’t see how it ever will since the laws that govern banks are written by politicians who are funded by the banks, and bankers themselves (or their lackeys, in the case of Geithner) move back and forth through government’s revolving door. When people say that big banking is good for nobody, they’re missing who it’s very good for: bankers and their friends. Too bad they’re the ones who regulate banking.

      You’re most welcome for the note, and thank you for the comment!

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