LIBOR: Viewing the Biggest Financial Crime in History01/03/2013 22:47
It’s been five years since a few academics and journalists began to dig up evidence that something was wrong with the London Inter-Bank Offered Rate, or LIBOR (pronounced appropriately as “lie-bore.”) The data that curious researchers were compiling couldn’t be explained using the prevailing definition of what LIBOR supposedly was: a trustworthy interest rate that accurately gauged the market price of borrowed US dollars held overseas by the world’s biggest banks. Instead, their findings pointed toward something other than an idealized neoliberal market, influenced only by impersonal supply and demand forces. Many began to realize that the data could easily be explained if the banks were rigging the LIBOR rate in their favor. Strange discrepancies in LIBOR’s correlation to other rates, and to the economic fundamentals of the bank companies responsible for formulating the rate, showed something seriously amiss, but it made sense if the banks were cheating.
The motives of the banks have been clear from the beginning. A few banks that dominate the marketplace for derivatives stand to make billions if LIBOR moves in their favor on particular days when contractual payments between them and their customers come due. They therefore suppressed the rates in order to skim billions of dollars off derivatives and investments. Later these same banks suppressed LIBOR rates to create the illusion that their balance sheets were robust during the financial crisis. This also allowed them further rounds of money-siphoning from their unwitting derivatives customers.
Until recently LIBOR rates have been set by a panel of banks that are members of the British Bankers Association (BBA). The BBA is a private industry group established almost 100 years ago to lobby for the financial industry in one of its global hubs, London. The BBA really came into power in the mid-1980s with the creation of LIBOR. LIBOR was created to further integrate the giant global money market in US dollars held in overseas banks or holding companies, and therefore unregulated by the US Federal Reserve. Called “Eurodollars,” because they originally were dollar savings accumulated in European banks, especially banks in London, these funds quickly became a de facto global currency. LIBOR began as a way for the banks to standardize investment products for these vast pools of American dollars flowing through Europe, and later Japan, the Middle East, and Latin America. By the 1990s LIBOR had become such an important set of interest rates, and US dollars held overseas had becomes such an important source of credit for US consumers, that LIBOR became the key global interest rate around which many financial products were pegged. As LIBOR became more and more important to the globalization of finance, it accrued a sort of official, trusty gloss; nearly everyone assumed that LIBOR was a market rate reflecting competition. Instead, LIBOR has probably all along been a fudged rate, determined less by vast market forces and invisible hands, and more by the vulgar self-interest and power of the elite banks that set LIBOR rates.
Last year government investigations into this globe-spanning crime —rightly called the biggest financial scam in all of history— led to multi-billion dollar fines against Barclays, the Royal Bank of Scotland, and UBS, the 7th, 8th, and 20th largest banks in the world, respectively. Criminal investigations spearheaded by US, UK, Japanese, Canadian, Swiss, and Singaporean authorities are ongoing and aimed at other banks such as Citigroup, JP Morgan, Bank of America, and other “too big to fail” institutions. More details of the crime will be forthcoming as e-mails, internal documents, phone tapes, text messages, and other evidence, is made public, and as the banks are forced to pay significant fines, and sign plea agreements.
While this scandal might seem worlds away, concerning complex financial concepts and obscure money market instruments dealt by bankers out of skyscraper offices in the City of London, the importance of uncovering the complete truth about the LIBOR rigging conspiracy cannot be overstated for local communities across the United States, especially here in California.
Why? First, LIBOR has been used since the 1990s to determine cash flows on interest rate swaps that local governments have purchased from banks to insure themselves against wild swings in variable interest rates owed on billions of municipal debt. Messing with LIBOR messes with the payments due on these instruments.
Second, LIBOR has also been used as a main interest rate of reference for an array of investment products that yield a variable return, dipping and rising in concert with LIBOR. Local and state governments have used these investment products, called “municipal derivatives reinvestment products” to temporarily park public funds, while pension systems and government enterprises like utilities use them make investments. Governments and public agencies earn LIBOR rate returns on their dollars invested in numerous kinds of municipal derivatives, so if LIBOR is illegally fixed downward, they earn less income.
Through both of these forms of exposure, local governments have potentially been harmed by LIBOR-fixing perpetrated by the banks, often times the very same banks that have sold them swaps or municipal derivatives investment products.