The European LIBOR scandal is quickly becoming the biggest scam in financial history, dwarfing any Wall Street scam to date.
What is LIBOR?
The London Interbank Offered Rate (LIBOR) is the average of interest rates submitted by the London mega banks used to calculate lending rates from one bank to another.
But in today’s global economy, LIBOR’s effects do not remain in Europe only and are felt by borrowers world over, including the United States.
How do LIBOR Rates impact you?
A variety of US loans and financial products such as mortgages, derivatives, and student loans use LIBOR as a reference rate. Manipulation of the LIBOR rates is tantamount to manipulation of the U.S. interest rates.
When rates and loans in the US are calculated using a manipulated LIBOR rate, the US borrower is hurt. For example, when banks in the UK lower the LIBOR rate, the US consumer faces even higher charges on his mortgage bill and credit card payments. The financial impact of these overpayments are a major and growing concern.
Thomson Reuters serves as the data collection service for LIBOR. Every day, banks all over the world send in their borrowing costs and interest rates. The top and bottom 25 percent of submitted data is not considered while calculating the LIBOR. The remaining 50 percent of rates are averaged to arrive at the amount. The LIBOR is considered the single most critical and pivotal benchmark when it comes to short-term interest rates. For the US LIBOR, 18 of the largest banks submit their rates every day.
The LIBOR scandal in a nutshell
During the Financial Crisis of 2007-2009, the overall condition of the market was very weak. At this time, banks wanted to ensure people that they were healthy and doing well financially. In order to do this, a variety of large and medium sized banks contacted each other and submitted daily borrowing rates that were lower than the actual borrowing rates. Early investigations reveal that Barclays and about 15 other global banks might be directly involved in LIBOR manipulation. It is now feared that these manipulations may have begun as early as 2005.
June of 2012 saw many of the top management heads at Barclays Bank roll after the LIBOR scandal made headlines all over the world. As of right now, Barclays is the only bank that has been openly penalized for their role in this scandal. New York University’s Thomas Cooley is right when he says, “It distorts trust in the marketplace if you can’t trust the rates at which banks are lending to one another.” By providing rates and data that were lower than the actual rates, these banks propagated the false notion that funds could be borrowed from them at cheaper rates. This further ensured that LIBOR calculators considered these banks less risky and therefore, more stable.
The current situation with the LIBOR scandal
Barclays Bank is in the throes of a financial crisis ever since the LIBOR scandal came under investigation. In late June 2012, Barclays was penalized for knowingly manipulating the LIBOR between the years 2005 and 2009. They have agreed on a settlement amount of $453 million that has to be paid to U.S. and UK regulators. While this amount is not loose change, it is in no way comparable to the multi-trillion dollars underpinned over the years or the full amount that this scandal is attributed to. But as already indicated, Barclays is not the only bank that contributed to this white collar financial wrongdoing.
The high profile management heads of Barclays — including the CEO Robert Diamond — have lost their jobs due to the role they played in this scandal. The investigation is far from over though. Regulatory authorities from countries like United States, United Kingdom, Canada, Japan and Switzerland are looking into the matter. It is expected that over the period of the next few weeks and months, more banks will be incriminated and brought to book by the investigation conducted by these regulatory authorities.
The central banks’ role
Even more shocking are documents released by UK Parliament and the New York Federal Reserve indicating that the central banks had adequate knowledge of the fact that the banks were blatantly lying and making fraudulent claims while submitting their borrowing rates. As Mervyn King, Governor of the Bank of England stated, the LIBOR rate is “in many ways the rate at which banks do not lend to each other… it is not a rate at which anyone is actually borrowing”.
Even though the situation appears to have been noticed quite a while ago, no action was taken against the banks involved. Their clearly harmful activities were allowed to continue and grow.
Implications of the scandal
After the settlement with Barclays and the predicted incrimination of other banks, the truth of the matter is now emerging. Analysts are now putting forward the idea that the daily submission of interest rates made toward LIBOR calculation must be based on the actual market price and not on any estimate of borrowing rates. Ronald Anderson from London School of Economics points out that as of right now, the LIBOR calculation is a process that is deliberately ‘not based on real transactions’. In view of the multi trillion dollar LIBOR scandal, this situation is most likely to change. Anderson argues that the daily rate quoted by banks ought to be the one at which ‘people really do business’. scandal
Central banks have also come under fire for turning a blind eye to these manipulations. With so much deserved criticism being sent their way, central banks will have to fulfill their monitoring obligations more vigorously.
The LIBOR scandal has run into trillions of dollars. With the scandal finally coming to light, it is possible that many U.S. banks will go under and the ultimate result might be a U.S. taxpayer funded Washington bail-out once again (will Americans ever get their money back from GM and Chrysler?). Analysts predict that Wall Street banks might be hit with billions of dollars in penalties and civil lawsuit payouts. If the claims and penalties against Wall Street become too high, a bail-out request might be on the cards. The implications of the LIBOR are so far reaching that it might ultimately result in bringing down Wall Street. Even if the unthinkable did occur, too many of these white collar culprits would just ride out the storm on their yachts.
These clearly hurtful financial wrongdoings have increased calls for white collars wrongdoers to face the judicial music as would their blue collar brethren. But despite such awareness, not one U.S. banker has been convicted and sent to prison since 2008.
LIBOR and the future
Conservative estimates calculate about $350 trillion tied to the LIBOR scandal while other higher estimates reach startling figures like $850 trillion. These are estimates calculated only for the U.S. dollar-LIBOR rates. Additional currencies are still another painful story. The implications of the LIBOR scandal ought to be ground shaking but with so many grass root and top echelon members in the banks and federal institutions being blamed, only time will tell how far reaching the implications and punishments meted out are.
There is a distinct possibility that the costs associated with this scandal will come from the man on the street instead of from the bankers on Wall Street.
Written by: Tomorrows Trends Staff