Concerning LIBOR

via Dantes Outlook Facebook Page

Once again the issue of accountability is questioned in the banking system. In finance, the line between accountability and responsibility becomes fuzzy as the system grows more complex. The real question is whether or not Barclays and other major banks are to be held accountable for manipulating LIBOR to their advantage, or if they are in fact responsible to be fair and honest in reporting. 



This might seem like a no brainer, but the fact of the matter is that everyone is out for themselves. LIBOR is merely a benchmark. It is included in bond price formulas used to establish borrowing rates between banks in order to structure payment returns. LIBOR is commonly used to determine a floating interest rate as opposed to a fixed interest rate in various forms of borrowing, from swaps to derivatives. Large banks report an individual rate and the average is then quoted as LIBOR. The botom line is that the system relies on faith. We trust that LIBOR and other reported benchmarks are a good representation of the market conditions. 

What happens when we place full faith and credit in the US Dollar, but the government abuses this trust and continues to borrow and spend without a determined limit, or sense of discipline? We get a downgrade, and the risk free rate (US Treasury quote) becomes questionable. We go with the flow anyway and price it in to our models. In the case of LIBOR, the real issue is that the reported rate was manipulated based on individual solvency with no regard for the market. A bank like Barclays reported a rate to be included in the average LIBOR that was essentially dictated by traders (as email records indicate) to compensate for their losses. 

The hope was that if a bank reports a lower borrowing rate, the return against that benchmark will be higher. It's pure arbitrage, and it should come as no real surprise. Regulators and media see the real issue of manipulation being sourced at the trading desks of these large banks.

I say that this comes without surprise because rate manipulation has a long history in traditional deposit banks and modern day investment banks. When the public takes out a loan, there is risk involved. The bank relies on deposits to provide more loans while decreasing risk. It's a never ending balancing act of hedging. Banks buy and sell financial futures and Certificate of Deposits (CDs) to not only attract new deposits at low rates, but also to profit from interest rate fluctuations. 

Regulators should ask themselves a critical question - is the manipulation of LIBOR reflective of market conditions? Banks were reporting a rate to be included in the LIBOR average based on maximizing their own bottom line. LIBOR is not an indicator, its a benchmark. What is considered a reasonable rate to report from each individual bank? No bank was an outlier, and rates were all within range. However, borrowing at pre-determined lower amounts should have indicated some concern. Overall, it is/was a failure of oversight. We now know that members of the Treasury looked into this several years back, but it failed to gain foot. 

 -Damanick Dantes