FIRST, THE GOOD news about the scandal surrounding alleged manipulation of the London Interbank Offered Rate, the benchmark interest rate known as Libor. Though many trillions of dollars in financial obligations — from adjustable-rate mortgages to complex derivative contracts — hinge on Libor, the potential impact of the banks’ alleged misbehavior on economic growth, both in the United States and globally, was probably negligible. The essence of the scandal is the misappropriation and misallocation of wealth, not its destruction.
And that is the end of the good news. Otherwise, the Libor scandal poses yet another threat to public confidence in the already troubled financial-services industry. Barclays has paid roughly $450 million in fines to U.S. and British authorities, admitting a series of irregularities between 2005 and 2009, while other banks remain under investigation. If a bank of the size and stature of Barclays could fiddle its borrowing costs, either to seem sounder than it actually was amid the financial crisis of 2008 or to rig particular trades, then we might be looking into a very deep moral pit indeed.
One lesson of the recently concluded uproar over “robo-signing” of mortgage documents is that the more pervasive and routine the financial wrongdoing, the more costly and complex it is to hold any individual accountable. Eventually, the banks, the government and the 50 states reached a $25 billion settlement to cut that Gordian knot. But the scope of the Libor issue could make the robo-signing mess seem minor. Any justice eventually meted out by the class-action lawsuits, out-of-court criminal settlements and Byzantine jury trials that may lie ahead will be rough at best.
Still, accountability must be pursued. There can be no justification for dishonest interest-rate reporting by the banks. Libor functioned according to an honor system, in which a private British banking association essentially counted on participants to provide accurate estimates of what short-term loans of various maturities in various currencies would cost them. Between the two varieties of reported wrongdoing — low-balling rates at the height of a financial crisis, possibly with the connivance, tacit or otherwise, of British regulators eager to stave off a panic in the markets; and outright manipulation of rates up and down to cheat counterparties — the latter strikes us as the clear enforcement priority.
Meanwhile, global financial authorities need to get busy on a project that’s been on their back burner since well before the behavior at issue in the Barclays settlement: coming up with an alternative to Libor. As Federal Reserve Chairman Ben S. Bernanke pointed out in congressional testimony last week, Libor is “structurally flawed.” It aggregates bankers’ self-reported estimates of the rates they would have to pay for loans, as opposed to the rates that they actually paid.
Financial markets have stuck with Libor mostly out of inertia, despite the obvious potential for abuse and despite the existence of possibly better benchmarks. On Sept. 9, the world’s central bankers will meet to consider new ideas, under the auspices of Bank of Canada Governor Mark Carney, who has wisely called for “radical” reform. It’s too late to unwind the trillions of dollars in existing deals tied to Libor, but not to develop a sounder system.