Little White Libor

The big problem with the Libor rate fixing scandal is that no one seems to be able to figure out who the victims were.  Barclay’s has been fined $450 million and had to fire its top three executives.  Four other big European Banks are now in the spotlight, and it won’t be long before Citi, JP Morgan and Bank of America follow them.  Attorneys general around the US are trying to figure out whom they can prosecute for what.  But they’re having a hard time because it isn’t obvious who, if anyone, got hurt.

Libor is the only interest rate I know of that is neither promulgated by a single institution (which is therefore accountable for it) nor based on actual transactions (which makes accountability moot).  Instead, at 11:00 AM (GMT of course), a bunch of unnamed “contributor banks” selected by the British Banking Association call Thompson Reuters and report how much they’re paying to borrow (not how much they’re charging to lend) short-term money from other banks.  Of course, not all of them are borrowing at any given time, so they are also allowed to report what they would expect to pay if they were borrowing.  Like the judges’ panel at a gymnastics meet, Thompson Reuters throws out the top and bottom quartiles, averages the rest, and then publishes that number as today’s Libor.

That “expect to pay” thing makes Libor pretty much a made up number.  At a bare minimum, it’s an open invitation for monkey business.  The number it produces has about as much integrity as the scores at the aforementioned gymnastics meet.

So, what did the monkey business look like?  As best I can piece it together, here’s what happened:

In August of 2007, a full year before Lehman failed, Bank Paribas announced that it was “freezing” three big mortgage-backed security funds.  The problem, Paribas said, was not that the funds had lost too much value, but that the market for the securities in those funds had become so illiquid that they couldn’t figure out how to value them at all.

Understandably, this made other banks with large exposure to the mortgage market (that would be “all of them”) nervous. So nervous, in fact, that they stopped lending to each other.  Each of them apparently was afraid that any other bank they lent overnight money to might not be around in the morning to give it back.

I have no idea what exposure these banks may have had to derivates that would have cratered if Libor had gone up.  I am pretty sure, however, that none of them wanted to admit publicly that its peers no longer found it creditworthy.  So they engaged in a few backchannel conversations and decided to report that they expected to pay about what they’d been paying.

I’m not a big fan of collusion or lying.  Unlike the morally bankrupt children of London and Paris, I learned all about George Washington and the cherry tree in primary school.  But the question of who got hurt is a good one.  I’m pretty sure that if interest rates had jumped 5-10 points in the fall of 2007, what we experienced as a meltdown would have been a full-blown crash.  It’s hard to imagine it being much worse than it was, but a DePaul finance professor told me the other day that the underlying conditions in 2007 were in fact much worse than they were in 1929.

It’s impossible to justify the means, but the ends seem like something we should be happy about.  Price fixing laws exist to keep prices from being artificially inflated, not deflated.  I can’t wait to see the lawsuit that says, “You boys have been brought before this court because you kept interest rates too low.”

This is what former Barclay’s CEO Bob Diamond looks like.

If you see him on the street, which I guess is where he hangs out these days, I think you should give him a hug.