Everybody knows

12/07/2012 § Leave a comment

The LIBOR scandal reminds me of the Leonard Cohen song that gives this post its title:

Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed.

The messing about with LIBOR just reminds us of how loaded the dice really are. I’ve been waiting a bit to post on it, because I’ve been trying to figure out how it affects the economy, consumers, and firms. A simple explanation is shown in an infographic that shows how returns to public investments (pension funds and the like) were skewed downward as a result of underreporting inter-bank interest rates. More detailed discussion of the scandal, the players, and the impacts can be found in Matt Taibbi’s reporting for Rolling Stone. In his post, ‘Why is Nobody Freaking Out About the LIBOR Banking Scandal?’, he conveys the significance of the scandal:

This story is so outrageous that it shocks even the most cynical Wall Street observers. I have a friend who works on Wall Street who for years has been trolling through the stream of financial corruption stories with bemusement, darkly enjoying the spectacle as though the whole post-crisis news arc has been like one long, beautifully-acted, intensely believable sequel to Goodfellas. But even he is just stunned to the point of near-speechlessness by the LIBOR thing. “It’s like finding out that the whole world is on quicksand,” he says.

I haven’t really understood quite how gaming the LIBOR affected consumers. The banks, after all, were generally pushing the rate downward. If I’ve got this right, the banks were increasing the spread between what they actually received in interest income and what they had to pay to institutional investors whose returns were linked to the LIBOR.

Regardless, two things that really stick out are:

  • banks were gaming the rates based on current holding and trading activity. The bias therefore wasn’t just a general downward one, but rather a revenue-maximising bias
  • commercial banks were doing this in cahoots with central bankers. It’s not entirely clear who knew what when, and who gave what approval. There is testimony planned for next week that may reveal more. Taibbi explains the essence (you can find the same explanation in other places if you don’t like him or RS):

The email from the CEO to the other two senior Barclays execs purports to detail the content of the conversation Diamond had with Bank of England deputy governor Paul Tucker that same day. In the email, Diamond essentially tells the other two execs that he has been given permission by Tucker – encouraged, actually – to rig Libor rates downward. What’s even worse is that Diamond’s email suggests that Tucker was only following orders….

Rigged. Loaded. Bent. The core of the global financial system that sets all kinds of prices for money and capital is as honest as three-card monte. That makes you and me chumps.

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