Could Libor rigging have an upside?
By Zachary A. Goldfarb and Jia Lynn Yang,
The revelation that Barclays and other big banks schemed to rig Libor, a critical global interest rate, sent shock waves across the world of finance.
Top bank executives resigned. Central bankers launched probes into how rates are set in Britain, Sweden, Japan and elsewhere. Some commentators called the scandal one of the worst in history.
But is it possible that the manipulation actually had an upside?
As analysts assess the fallout, there has been a lot of fog and little clarity about the precise impact on the global economy, markets, investors and average consumers. While many lost because of the rigging, many others, aside from the banks, may have benefited.
“Sorting out the winners and losers in terms of following the money and how it nets out is going to be tremendously complicated,” said Stephen Bainbridge, a professor of business law at the University of California at Los Angeles.
Barclays was found to have reported sometimes artificially low rates, so consumers whose mortgages, auto loans or student loans were linked to Libor may have paid less. On the other hand, investors who were paid interest based on the benchmark rate, which included investment funds and municipalities, would have lost out.
Perhaps the most difficult question about the scandal is whether violating the public trust — especially when much of the illegal activity occurred in the credit crisis of 2008 — helped prop up the financial system overall.
In part because it was often reporting lower borrowing costs, Barclays was treated in the crisis as one of the world’s strong banks. In fact, officials at the Federal Reserve and elsewhere tried to get Barclays to buy Lehman Brothers as it was collapsing.
Some analysts speculate that for this reason, the Fed may not have pushed aggressively to stop the rigging of Libor, even though it had evidence in 2007 that the rate was aberrant.
“There is a tension, and they opted for the path of least resistance . . . which is to acquiesce in the rigging of the Libor rate,” said Cornelius Hurley, a law professor at Boston University and former Fed lawyer. “That just happened to coincide with what they were trying to do — which is free up the credit crisis.”
On multiple occasions during the financial crisis, federal regulators, including the Fed, weighed whether to overlook the enforcement of regulations in order to protect financial stability. In some cases, they sidestepped rules; the Fed has faced congressional allegations of doing so, but no definitive proof has emerged.
With Libor, officials say they responded promptly to what they learned, alerting the appropriate authorities in the United States and Britain.
“The United States, to its credit, set in motion at that stage a very, very powerful enforcement response, the first of which you’ve now seen,” Treasury Secretary Timothy F. Geithner, head of the Federal Reserve Bank of New York at the time Libor was being rigged, said this week at a conference. “And there’s more to come.”
Central bankers, who have been under fire, are planning to meet to discuss alternatives to Libor. Geithner will face sharp questions on Libor in Congress next week.
Since June 27, when Barclays settled its Libor case by paying a $450 million regulatory fine, many have said the bank’s actions amounted to an egregious breach of public faith that will damp confidence in financial markets. The bank also acknowledged that several traders rigged the rate for personal profit, sometimes increasing the rate.
“Prices are fundamental mechanisms for savings and investment decisions — even the decision to eat today versus to save for tomorrow depends on good, accurate prices,” said Andrew Ang, a Columbia Business School professor. “We all lose by having bad prices. It undermines free markets.”
Although the scandal adds to concerns that Wall Street lacks respect for the rules, the markets overall seem unperturbed.
The U.S. stock market is up 4 percent since the scandal was unveiled, and bank stocks have also done well, except for Barclays. Libor rates have barely moved.
Libor, which stands for London interbank offered rate, plays multiple roles in the world economy. It’s the benchmark for trillions of dollars of private student loans, credit cards, auto loans and mortgages. Set in London after large banks from the United States, Europe and Japan submit their borrowing costs to a tabulator, it’s also used in hundreds of trillions of dollars worth of financial contracts, known as derivatives.
Barclays has indicated in testimony and in e-mails, now public, that it wasn’t the only one trying to rig the rate.
Libor is so pervasive in the financial system that it’s difficult to follow the complex chain of events stemming from any single action.
“It’s a zero-sum activity,” said Connan Snider, an economics professor at UCLA who wrote a paper in 2010 raising questions about how Libor is calculated. “If you know the banks are enriching themselves by doing this, then it sort of has to be at the expense of someone else, even if it’s difficult to figure out who’s on the losing end.”
A borrower, for instance, could have paid less than they would have otherwise for a loan because the interest rate was rigged to be lower. But that would mean the bank is making less money off the loan.
The Community Bank & Trust of Sheboygan, located outside Milwaukee, has filed a lawsuit against the major banks saying that this very thing happened to smaller community banks. Cities such as Baltimore are also filing suit.
“There are two sides of every Libor-based transaction,” said David Kotok, chairman and chief investment officer of Cumberland Advisors. “Somebody had to lose for somebody else to have had a windfall.If you overpaid, then somebody underreceived, and vice versa”