The growing kerfuffle over Barclays Bank’s false reporting of its input into the London Interbank Offered Rate (LIBOR) is big news in Europe and among U.S. finance specialists. But it is not on the radar screen of the general public and it isn’t visibly affecting stock or bond markets.
This contrasts with the hullabaloo over JPMorgan’s $2 billion-plus losses in derivatives markets last month.
Yet the U.S. Commodity Futures Trading Commission and Securities and Exchange Commission are playing as large a role as the British bank’s home regulators in investigating what at first glance appears as a fairly minor lie about some hypothetical interest rate.
Who actually was harmed by what Barclays and more than 20 other banks did, and why should the average American care?
Start with the London Interbank Offered Rate itself. It is more complicated than it may seem.
LIBOR encompasses a set of interest rates charged by one London-based bank to another for loans of different terms, from overnight to one year, and for 10 distinct currencies. The rates are tabulated daily from data submitted by member institutions of the British Banking Association.
Contributors don’t report on actual loans they took out that day. Rather, each makes a subjective estimate of the rate at which it “could” borrow funds. Banks that participate in any particular panel are chosen because they are highly active in the market in question and usually make such borrowings multiple times each day.
LIBOR is not easy to manipulate by a single bank, because only the middle 50 percent of reported numbers are actually averaged.
Submissions are not weighted by each bank’s actual borrowing volumes. So the number sent in by a smaller bank borrowing millions in any one day has the same influence on the tabulated result as one by a bank like Barclays, which may borrow billions.
LIBOR quotes are important because they are “reference interest rates.” In other words, interest rates on actual business and household loans including credit cards, auto loans and home mortgages may be set or reset in terms of a number of percentage points above the tabulated LIBOR. And enormous quantities of other financial contracts are tied to one or more LIBOR rates.
Borrowers with loans the interest on which was tied to LIBOR would be hurt if Barclays or others succeeded in artificially pushing up rates. Their creditors would benefit, at least to the extent that their cost of funds being lent was fixed.
To the extent that the general public is paying attention, there seems to be a perception that this affair involved conspiring to raise interest rates above true market levels and thus fraudulently transfer money from borrowers to creditors. But this seldom happened. In many cases, Barclays and others acted to depress rates. This actually would have benefited business and household borrowers.
Moreover, for nearly any derivative security such as an interest rate swap or credit default swap tied to LIBOR, for every party that gained, there would be a corresponding loser. And the same banks that were reporting interest rates to the Bankers Association also were players in derivative securities markets, trading for their own accounts. This was particularly true of Barclays, the fourth biggest bank in the world.
Finally, for reasons too complex to detail here, changes in interest rates affect the market value of banks themselves. In this case, lower interest rates tended to boost the price of Barclays stock and higher ones lowered it. So to the extent that Barclays could bring about a change in the tabulated LIBOR, it falsely pushed up its own stock price.
The verb “bring about” a change in LIBOR is important. Huge as Barclays is, it would have been very difficult for it to move LIBOR all by itself, because of the way high and low reported values are discarded. To have much effect, tacit or overt collusion with other contributor banks was necessary. Here, Barclays’ contention that it was being singled out because it was the first malefactor to fess up has some validity. So much of the story remains untold.
There are broader questions. One is that of national economic policy and, in particular, the actions of central banks. These are based on the assumption that supposedly objective data, like prevailing interest rates, reflect market realities. To the extent that fraudulent data leads to bad public policies, society as a whole can suffer. So this is a bigger story than most people yet realize.
Write Edward Lotterman at ed@edlotterman.com.
