In the end, that’s what the banking industry is founded upon: Trust. You give total strangers a lot of money — whatever “a lot of money” means to you — and you trust that they will be honest and competent stewards of whatever wealth you have accumulated.
But that trust is disappearing.
As banks have gotten deeper and deeper into high-risk ventures, as a banking culture of restraint and prudence has disappeared, replaced by a cowboy ethos, trust in the judgment and integrity of the banking industry as a whole has eroded badly, and for good cause. The LIBOR scandal now making its way onto the front pages of newspapers here in the United States and in Europe will only accelerate that process.
The story may seem complicated at first, but it isn’t. LIBOR stands for London InterBank Offered Rate, and is based upon the average rate that big banks charge each other for loans. The process of establishing the LIBOR rate is simple: Major banks submit the latest interest rates they have paid to a committee. The high and low rates are ignored, the remaining rates are averaged to produce the LIBOR rate. That rate is then used as the benchmark for literally millions of transactions around the globe, involving an estimated $350 trillion.
The LIBOR scandal is about how that rate was manipulated by banks to produce higher profits for those on the inside, at the expense of those on the outside. In blunt terms, it’s about how major banks rigged the game in their favor.
The allegations can be broken into two basic categories:
1.) Prior to the 2007-08 banking collapse, major banks were allegedly manipulating LIBOR to produce higher profits for themselves. If a bank’s traders needed a lower LIBOR to maximize profit on major deals, the bank would report a falsely low lending rate. If they needed a higher LIBOR to make their financial bets pay off, they would report a falsely high interest rate. Internal emails released from Barclays, the first major bank to settle in the scandal, reveal that bank officials knew that they were rigging the market for their own benefit, and that they were relatively blase about doing so.
As a result of a settlement with regulators, Barclay’s top executives have been forced out of their jobs, the bank has agreed to pay fines totaling $452 million to U.S. and British regulators, and criminal investigations are under way in the United Kingdom. And while Barclays’ involvement has been the first to be exposed, there is no expectation that it will be the worst offender. Most if not all of the major banks may be implicated in the end.
2.) During the 2007-08 global banking crisis, banks allegedly manipulated the LIBOR rate to make it seem that they were still lending to each other at relatively low interest rates. By reporting lower interest rates than they were actually paying, the banks hoped to make it appear to outsiders that the financial system was healthier than in fact it was, in hopes that the false confidence would help avert a panic.
In Britain, there is some indication that financial regulators ignored or even endorsed LIBOR manipulation through the crisis because they too were working feverishly to keep the system afloat. Here in the United States, there is some indication that the Federal Reserve Bank of New York at least had suspicions that LIBOR was being manipulated, although it is uncertain how aggressively it pursued those suspicions at a time when it too was trying to keep the system afloat.
In brief, that’s the scandal. Of the two main allegations, the charge that banks were manipulating LIBOR on a more or less daily basis — in effect rigging the market on their own behalf, at the expense of their own clients in some cases — is by far the more serious. The alleged manipulation of LIBOR through the banking crisis was at least understandable, although the potential involvement of financial regulators in that process is disturbing.
However, the most disturbing aspect of the scandal is how well it fits into the emerging picture of international banking as a system that shuns stability and chases risk, because with high risk comes high potential profits and personal bonuses. It reflects a modern banking culture that treats other people’s money as, well, other people’s money, with little regard to a sense of fiduciary duty.
It is not the type of corruption in which a few bad apples are caught cheating the system. It is the type of corruption that has become inherent in the system, and that’s far more troubling.
– Jay Bookman