LIBOR – a tobacco moment for banking?

Here’s a super leader from the Economist on the LIBOR scandal…the video is pretty good also.

“Since we have not more power of knowing the future than any other men, we have made many mistakes (who has not during the past five years?), but our mistakes have been errors of judgment and not of principle.” So reflected J.P. Morgan junior in 1933, in the middle of a financial crisis. Today’s bankers can draw no such comfort from their behaviour. The attempts to rig LIBOR (the London inter-bank offered rate), a benchmark interest rate, not only betray a culture of casual dishonesty; they set the stage for lawsuits and more regulation right the way round the globe. This could well be global finance’s “tobacco moment”.

it goes on:

…That could end up costing the banks a lot of money. LIBOR is used to set an estimated $800 trillion-worth of financial instruments, affecting the price of everything from simple mortgages to interest-rate derivatives. If attempts to manipulate LIBOR were successful—and the regulators think that Barclays did manage it, on occasion—then this would be the biggest securities fraud in history, affecting investors and borrowers around the world. That opens the door to litigation not just by the direct customers of implicated banks, but by anyone with a financial interest in LIBOR. The lawsuits have already begun.

For the uninitiated amongst us it’s a fairly horrifying journey to discover how LIBOR is calculated. Here’s the Wiki:

The London Interbank Offered Rate is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks. It is usually abbreviated to Libor or LIBOR, or more officially to BBA Libor (for British Bankers’ Association Libor) or the trademark bbalibor. It is a benchmark, along with the Euribor, for interest rates all around the world.
Libor rates are calculated for different lending periods: overnight, one week, one month, two months, six months, etc., and published daily after 11 am (London time) by Thomson Reuters. Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to (and typically higher than) Libor.

OK, all well and good so far, and there’s quite a simple and elegant bit of Maths to settle the rates – the interquartile mean of rates submitted (by between eight and twenty banks depending on the currency) is calculated (ignore top and bottom 25% as outliers and average the middle half).
It’s one of those things however when elegance disguises lack of substance. There is no designed process for the banks’ estimates with no requirement to relate to any actual transactions.
So back to the detail in the Economist again – the rotten heart of finance.

In theory, LIBOR is supposed to be a pretty honest number because it is assumed, for a start, that banks play by the rules and give truthful estimates. The market is also sufficiently small that most banks are presumed to know what the others are doing. In reality, the system is rotten. First, it is based on banks’ estimates, rather than the actual prices at which banks have lent to or borrowed from one another. “There is no reporting of transactions, no one really knows what’s going on in the market,” says a former senior trader closely involved in setting LIBOR at a large bank. “You have this vast overhang of financial instruments that hang their own fixes off a rate that doesn’t actually exist.”
A second problem is that those involved in setting the rates have often had every incentive to lie, since their banks stood to profit or lose money depending on the level at which LIBOR was set each day. Worse still, transparency in the mechanism of setting rates may well have exacerbated the tendency to lie, rather than suppressed it. Banks that were weak would not have wanted to signal that fact widely in markets by submitting honest estimates of the high price they would have to pay to borrow, if they could borrow at all.

Right so Barclays have been fined £300m for attempting to manipulate LIBOR , the chair and Chief Executive have resigned and the share price has slumped…..all over?
Maybe not: (from istockanalyst). There’s a lot of numbers there – the analysis looks at the 3 month $ LIBOR and reaches no conclusion on collusion but the fact is that Barclays were consistently the highest submitter and thus routinely eliminated from the LIBOR calculation.
OK – what does that mean? – Back in the Economist article:

The allegation by Barclays that some banks seemed to be fiddling their data would appear to be supported by the data themselves. Over the period of the financial crisis, the estimates of its borrowing costs submitted by Barclays were generally among the top four in the LIBOR panel (see chart 2). Those consistently among the lowest four were some of the soundest banks in the world, with rock solid balance-sheets, such as JPMorgan Chase and HSBC. However, among banks regularly submitting much lower borrowing costs than Barclays were banks that subsequently lost the confidence of markets and had to be bailed out. In Britain these included Royal Bank of Scotland (RBS) and HBOS……
…Regulators around the world have woken up, however belatedly, to the possibility that these vital markets may have been rigged by a large number of banks. The list of institutions that have said they are either co-operating with investigations or being questioned includes many of the world’s biggest banks. Among those that have disclosed their involvement are Citigroup, Deutsche Bank, HSBC, JPMorgan Chase, RBS and UBS…….
A particular worry for banks is that they face an asymmetric risk because they stand in the middle of many transactions. For each of their clients who may have lost out if LIBOR was manipulated, another will probably have gained. Yet banks will be sued only by those who have lost, and will be unable to claim back the unjust gains made by some of their other customers. Lawyers acting for corporations or other banks say their clients are also considering whether they can walk away from contracts with banks such as long-term derivatives priced off LIBOR.

Tobacco moment? Lawsuits and settlements cost America’s tobacco industry $200 billion in 1998.
This could be worse…more banking bailouts….?

Welsh Nationalist. Rugby Fan. Know a bit about History and Railways…

  • aquifer

    If banker both understated the interest rate and personally received higher bonuses due to a lower cost of borrowing, they seem to be guilty of fraud, and collectively, conspiracy to defraud.

    Is there a court with a dock big enough?

    Maybe we should just intern them until things settle down.

  • LIBOR is one banking scandal that will result in multiple lawsuits but I wonder if the outbreak of that scandal was its “tobacco” moment. The banks are being hit or set to be hit in other ways:

    Mis-sold Payment Protection Insurance –

    In 2011, the Banks were held liable for about £1.9 billion in mis-sold PPI claims but there is far more to come. Only last March, Lloyds set aside an extra £375 to meet these claims.

    Claims relating to irresponsible lending –

    So far, the banks have got off relatively lightly. Notwithstanding the changes brought about by the 2006 Consumer Credit Act and the MCOB rules, there has still not yet been a reported case of irresponsible lending which has gone against a lending institution. I believe that will happen soon and it will open the floodgates to claimants.

  • I think LIBOR is certainly “the point of no return”. Previous scandals and Id include the broader financial instiutions rather than “just” banks.
    The anger possibly began with the mis-selling of private pensions but to some extent must have realised that some of those duped into giving up some entitlements were greedy and stupid.
    The anger has also to include the accountants who advise on tax avoidance schemes and pay day loan adverts on TV.
    Too many previous scandals have been marginalised. The local banks fined for being over-enthusiastic in persuading people to board planes for the Isle of Man. The over-charging scandals in respect of overdrawn accounts…..didnt the High Court rescue banks from bigger pay-outs which would have resulted from TV campaigns from consumer advocates.
    I think LIBOR is not so much th “tobacco moment” …just one more moment that helps consumers decide that bankers are not exactly ethical.
    And I think this is part of a general decline in ethical standards across many professions….
    And the reaction is in part generational.
    Younger people tend to assume that this is how bankers behave. Those of us who remember a different kind of banker…..a middle aged grey man who actually had a face and a name….are the only people really shocked.

    Big Law Suits? Yes but not as crippling as mentioned. The Banks will… is the norm… rescued. Different rules apply. The Banksters as they have now become known operate under different rules.
    They enriched themselves and impoverished many but they are protected by the notion that they have the unique skills to get us out of this mess.

    Long term effects. Well we are all too lazy about bans and banking. In part this is because many of us in middle years with families are tied into banks. They hold the mortgages. They hold the overdrafts. They “own” too many people.
    Eventually of course in later life the motgages get paid, we breathe a collective sigh of relief that we have outlived our fears. We swear (when we are 30 40 and 50) that when we are able to do so….we will tell the bank to get stuffed. But ……we dont. Its too much hassle.

    So we bank as an individual with a bank for 35 years or asa couple for 30 years. So what people SHOULD do…is not rely on big fines or law suits which wont benefit individuals….the costs will be passed on anyway….thru pension investments etc. It will cost US in the end.
    No ……what people SHOULD do is go into the High Street branch and move that account…… ANY other bank, preferably a mutual society or credit union.
    Wont get fooled again…except of course we will.

  • Dewi

    The scale difference maybe SM is the global effect of LIBOR decisions on transactions with no direct relationships to banks.
    A loan placed in Bogota could have been overpriced because of this…the scale of potential litigation is frightening.

  • sherdy

    The banks will always have the trump card: ‘Put us in the dock and we will collapse the economy’.
    So far no government has found the answer to that.

  • Mister_Joe


    You don’t need to put them all “against the wall”. Just a few to encourage les autres.

  • sherdy

    Mister Joe – You like the idea of a ‘smoking gun’ then?

  • Mister_Joe

    I’d love to see a class action (individuals can’t really afford it) by those who lost their homes, preferably in the USA, against those banks who loaned them the money to buy houses they couldn’t afford. A case of gross negligence could be made, I am sure, although they wouldn’t deserve 100% of their losses due to their own irresponsibility.

  • Greenflag

    It’s just more evidence that the elected politicians of the time and the regulators not just of the UK but in the USA and Ireland all had their heads where it’s dark and smelly and could’nt be arsed to question the bankster bosses as the latter combined greed upon stupidity for the sake of massive profits for a tiny minority of insiders .

    Gordon Gecko lives still and our politicians continue to lie low and pretend the banksters don’t have them by the short and curleys 🙁

    Thanks Dewi for the link -We’ll see how much this ‘discovery’ will redound on world markets next week .

  • Greenflag

    The first law of bankers is :
    And woe betide the banker who doesn’t heed it :
    Never lend any money to anybody:
    Unless they don’t really need it !

    Some things never change

  • Alias

    Can borrowers afford an accurate Libor rate? It’s part of the same scam where the EU ‘stress-tested’ its massively over-leveraged banks and instead of truthfully declaring them insolvent, declared them to be in sound financial health. Truth in both cases would have decreased liquidity by increasing the CDS rate.

  • Mister_Joe

    As I understand it, an accurate Libor rate cannot exist. Banks don’t have to report what they actually paid other banks for loans, just what they think they would have had to pay should they have requested a loan. That is, of course, wide open to abuse. The LIBOR should be an average of what banks did pay and those that lie should pay a penalty, up to and including a custodial sentence and a lifetime ban on banking in any form.

  • Alias

    No one is referring to algorithms, but to accurate an assessment designed to guide the market as opposed to an inaccurate one designed to mislead it.

    The Libor rate was manipulated to lower the cost of borrowing – which is why those who lost money by lending at artifically lower rates may now sue.

  • Dewi

    Or higher Alias …..all transactions have a winner and loser…..and I reckon the loser could sue and win..

  • The Raven

    All this huge stuff. All of it quite frightening – not a word I use glibly. It genuinely is scary.

    Tiny steps can lead to big things. I’ve switched my meagre savings to the Cooperative bank and my local credit union, leaving only a current account in a “mainstream” bank for depositing wages/paying direct debits. I wonder if we can persuade lots of others to do the same?

    And on the same note, isn’t it about time credit unions were given a little more of a push by central government as an alternative to Big Finance?

    Oh…silly me.

  • Alias

    There is no suggestion so far that Libor was manipulated to increase the rate of borrowing. In Barclays case, the incentive was to lower it so that the rate at which it could borrow unsecured money was falsely presented as being lower than it actually was. In other words, it was done to make Barclays look a better credit risk than it actually was, thereby lowering its CDS rate. That deception worked for the Bank of England too which would otherwise have to ask the government to recapitalise Balclays in the same way that it had to with RBS and Lloyds – a fate that Barclays was also desperate to avoid at that time. It should also be noted that banks would have to act in concert to manipulate the rate since any bank that was way out of whack among the contributer banks would be rejected via a mean average that rejects the lowest and highest rate, so you really have to look at this as a bank not wanting to publish the fact that its own cost of borrowing had spiked. If the banks did act in concert then you’re looking at massive fraud and lawsuits left, right and centre. Low cost short term interbank funding is probably the only factor apart from state recapitalisation that is keeping these fundamentally insolvent banks in business.

  • Dewi

    “If the banks did act in concert then you’re looking at massive fraud and lawsuits left, right and centre.”

    Yep – LIBOR manipulation is not possible without collusion.

  • Greenflag

    @ Dewi

    IF is a short word and is indicative of some doubt .

    Fast back to 1937 in Prague , Czechoslovakia three men are deciding who will win the inevitable next war by tossing a coin .
    Marek says Germany will win if it lands on heads .Vaclav says the Soviet Union will win if it lands on tails .

    Tomas says Czechoslovakia will win IF it lands on it’s edge ..

  • Greenflag

    @Raven ,

    ‘It genuinely is scary.’

    It’s worse than that . It’s further evidence as if it was needed that most our ‘politicians ‘ at least in respect of this scale of financial conjuring haven’t a clue and those who do have either been bought off or haven’t the balls to tackle the problem . The banks who were too big to fail still hold the upper hand and even the upcoming USA election will be a meaningless charade as neither party will ‘break up ‘ the biggest 10 banks who now ‘own’ the US economy .