Friday, July 13, 2012

LIBOR scandal

This planet has — or rather had — a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movement of small green pieces of paper, which was odd because on the whole it wasn't the small green pieces of paper that were unhappy.

What is a dollar worth? Whatever the market determines that it's worth. It's a fiction. A mutually-agreed fiction by all involved, to be more specific. The market is just an accumulation of our preferences and beliefs on how much the dollar is worth. Put another way, how much value the dollar storesThis is even more true today as our conception of money becomes increasingly abstract. Our money is looking a lot less like paper and a lot more like the way electrons appear on a digital screen. An electronic fiction.

It is a fiction that starts with the printing presses and monetary policies of the US government, but then it begins to take on a life of its own. As people gain and lose faith in the American government, the American economy, and the American banking system - the value goes up and down accordingly. Unemployment claims drop, the dollar goes up. Livestock get infected by disease, the dollar drops. Another Wall Street fraud is uncovered, the dollar drops again. A thousand little changes a day. It becomes no surprise that monetary policies - may it be quantitative easing or fine-tuning of interest rates - is an inexact science at best. We put our brightest minds up to the task of leading the Federal Reserve and it still takes a long time to get anywhere near consensus. 

Is the LIBOR scandal the largest financial scandal in history? Well, it depends on what defines "largest". 

The London Interbank Offered Rate (LIBOR) is a calculated index that shows at what interest rate banks borrow money from other banks. It is published daily in 10 different currencies for 15 different borrowing lengths. Banks are supposed to independently submit this information to Thomson Reuters, who then chops off the highest and lower quarters and averages the rest. The scandal is that Banks colluded on what information to submit to Reuters to artificially lower interest rates.

There is no denying that interest rates on trillions of dollars of assets were all tied to the LIBOR rate. More assets that the US housing bubble. The LIBOR rate didn't just happen in a vacuum though. People traded assets on plus or minus the LIBOR rate and the amount of faith they had in the respective governments, economies, and banking systems that the rate was founded on. What happens when we all believe in the same fiction, doesn't that fiction become reality? Isn't it the same story as currency in general? Yes, the interest rate on borrowings was lower than it should have been, but that also means that it was cheaper for everyone to borrow money. In a recession, isn't that a good thing?

Baltimore is suing the major banks because they believe they would have made more money on the interest rate swaps that they owned if the banks were not manipulating the rates. I doubt it. They would have bought and sold swaps at slightly different rates and would have made out all the same. Different fiction. Same result.   They can't even put a dollar amount on what they think they would have gotten differently in this alternate universe. That's the problem with alternate universes though, they didn't happen so you can never prove anything otherwise. They might have had a 1.25% instead of a 2.00% return on their savings, but would have bought their interest rate swaps at 6.25% instead of 5.5%. It would have canceled out. This is the closest thing I can find to a victim of this scandal. They will probably settle out of court for a trivial amount. 

So, is this the largest financial scandal in history?

In the amount of assets affected, probably. In the amount of assets cheated/stolen/frauded out of, not even close. I would say that the shenanigans that Ponzi pulled a century ago were larger and that wasn't even that big compared to what has happened recently.

We can clean up the LIBOR mess just by following Tim Geithner's recommendations from 4 years ago.

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