It’s a scandal that has cost one top banker his £14 million ($21.2m) a year job.
It cost his bank £290 million ($440m) in fines.
And, on the back of other recent scandals (JPMorgan’s USD$2 billion trading loss, and UBS’s USD$2.3b rogue trading loss) it could threaten London’s spot as the world financial capital.
We’re referring to the Barclays’ LIBOR (London Interbank Offer Rate) scandal, and the attempts by bankers to rig the USD$360 trillion market.
We get it that folks have got their pants in a twist about attempts by a group of bankers to rig a market. But there’s another group of bankers who have got off scot-free. They continue to rig the market to this very day.
In fact, within hours of the exec’s resignation, this other group of bankers showed no shame. They released their latest wave of market manipulation…
Last week, Reuters reported:
‘China, the euro zone and Britain loosened monetary policy in the space of less than an hour on Thursday, signalling a growing level of alarm about the world economy…
‘…the surprise move was from Beijing which lowered its lending rate by 31 basis points to 6 percent following an interest rate cut just a month ago that also came out of the blue.
‘The European Central Bank cut rates to a record low 0.75 percent following a dire run of economic data. But it steered clear of bolder moves such as reviving its government bond-buying program or flooding banks with more long-term liquidity.
‘The Bank of England, whose rates are already at a record low 0.5 percent, said it would restart its printing presses and buy 50 billion pounds of assets with newly created money to help the economy out of recession.’
The regulators found Barclays guilty of fiddling with LIBOR so it could profit at the expense of others. That includes Barclays own customers.
But as far as fiddles go, Barclays’ efforts are small-fry compared to the world’s central bankers.
Fiddling with the Interest Rates
We’ll show you what we mean. The big evidence against Barclays is that in late 2008 its interest rates – as declared for the calculation of LIBOR – were higher than the other banks that take part in setting LIBOR. As this chart from the Economist shows:
You can see that as markets crashed in 2008, and banks went bust, interest rates went up. Why? Because savers demanded a higher interest rate in return for lending money.
So far, so good.
But while banks began pricing risk properly – although much too late – the mother of all interest rate fiddles kicked in.
You see, in 2008 interest rates should have moved higher (as they did) and then stayed higher (as they didn’t) for a period of time.
This would have drawn in savers who would have been prepared to lend money in return for a higher interest rate.
Trouble is, high interest rates were the last thing a certain group of bankers wanted. They knew that with all the high-risk and bad loans on the market, high interest rates would see the value of these assets plunge.
Remember that bond prices move in the opposite direction to bond yields. So if banks hold a whole bunch of high risk debt, and the interest rate soars, the value of this debt falls. And that would have a negative impact on bank balance sheets.
So, this other group of bankers put their plan into action. They used every power and tool to hand to force interest rates lower. As the following chart shows:
At the start of 2008, the interest rate was 4.25%. By August the bankers had pushed the rate down to just 2%. And just a few months later, the ruse reached an epic scale as they forced the rate to below 0.25%.
You know who we’re talking about. We’re talking about the leader of this interest rate fiddling cartel, the US Federal Reserve.
Still Messing With the Interest Rates – Four Years Later
When interest rates should have risen to reflect higher risk, Fed Chairman, Dr. Ben S. Bernanke pushed them down…to an all-time record low.
It’s funny. Barclays played with a key interest rate for a few months in 2008. Yet four years later, the Fed and the world’s other major central banks are still manipulating interest rates, and on a much bigger scale.
One man (ex-Barclays CEO, Bob Diamond) loses a high-paying job and almost branded a crook for his bank’s part in something he possibly knew nothing about. Then there are many other men (Bernanke, King, Draghi and Stevens) branded as geniuses for their active part in playing with interest rates on a much bigger scale.
Of course, you shouldn’t for a minute think that we’re on the side of the banks.
As central banks printed money, the banks have willingly taken part in it and benefited. Money printing that has devalued the wealth of prudent savers while at the same time keeping the banks afloat, allowing the likes of Bob Diamond to earn £14 million per year.
The big number touted is that LIBOR impacts a USD$360 trillion market for interest rates. That’s undoubtedly a big number. And as Dylan Matthews writes in the Washington Post:
‘The LIBOR scandal was Barclay’s making money by hurting you…
‘That means that when LIBOR rises, so do the prices ordinary consumers pay to, say, get a mortgage. Which means a bank that mucks with the LIBOR rate isn’t just playing around with esoteric derivatives that will only affect other traders: They’re playing with the real economy that most of us participate in every day.’
That’s right. But it misses a much bigger point. And that is, LIBOR isn’t a standalone interest rate. The banks determine the rate. And how do banks determine it?
That’s right, based on the rates set by other banks and…central banks.
If LIBOR impacts USD$360 trillion-worth of securities, we can only guess the value of all securities that rely on central bank interest rates to determine their price. $600 trillion…$900 trillion…$1 quadrillion…More?
An Interest Rate Headline You Haven’t Seen
Stock markets don’t rise or fall on the latest LIBOR rate announced in London each day. But they do rise or fall based on the latest fiddling by central banks.
Look at the market rally in 2009 when the US Fed began printing money (now known as QE I), and again in 2010 when it started QE II.
Look at the volatility in stock markets in recent months. Stocks have soared then sank as traders bet on the European Central Bank coming up with new schemes to boost the European economy.
We don’t ever remember reading a news story with the headline, ‘Market Soars/Crashes as LIBOR Hits New High/Low’. But we do remember these headlines:
‘European stocks advance on stimulus hopes’ – Sydney Morning Herald
‘Asian stock markets climb as Japan central bank calls unscheduled meeting’ – Fox News
‘World stocks, euro up on apparent ECB bond buying’ – BusinessWeek
And don’t forget that one of the key inputs for the Black-Scholes options pricing model is the ‘risk free interest rate’. In other words, the price of government bonds, which are in large part determined by central bank interest rates.
In short, we’re sure that Barclays fiddling about with LIBOR is a big scandal. And it’s right that heads should roll.
But compared to the fiddling by the world’s central bankers, the LIBOR banking scandal is a drop in the ocean. If the regulators really are serious about stamping out undue fiddling of interest rates, they should look no further than the biggest fiddlers of all – the central banks.
They’re the folks who should lose their jobs and go to the slammer. But that will never happen.
After all, it would make for an awkward situation. Especially as central banks not only fiddle with interest rates, but in most countries they are one of the major regulators too!
Cheers,
Kris.
P.S. Don’t forget to check out Greg’s interview on China and the bust you’ll want to avoid. Click here to watch now.
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