Libor: Is The City of London Fixed?

Dragon, City of London.jpg

Having worked inside banking, do I think that banks colluded to post an artificial London interbank offered rate, otherwise known as Libor? For those not in the brotherhood, that acronym is a compendium of average borrowing prices from sixteen large banks, pronounced either as lee-boar or lie-bore. Before turning to conspiracy theories, let’s review the facts of a scandal that began more than four years ago, and are so murky that I, for one — despite twenty-five years in international banking — have a hard time grasping.

In 2008, around the time of the September panic, Barclays and perhaps other large banks began obfuscating the true costs of their interbank borrowing, and submitted rates to the “fix” (in all senses of the word) that were less than their actual cost of funds. Why?

Few creditors wanted to take a chance on leaving their deposits in large European or American banks, especially since so many, such as Lehman, Merrill Lynch, Countrywide, and the UK's Northern Rock were shuttering their branch windows.

Only by paying over the market rates could banks like Barclays fund their bloated balance sheets of subprime assets. (Big banks in 2008 were more like pyramid schemes.) If the market got wind of their true borrowing costs, it would have eroded what little confidence was left in the banking system. Barclays and the British government concocted (shall we say colluded?) to post rates to the Libor “fix” that did not reflect the bank’s actual cost of borrowing funds.

As in Olympic scoring, when setting the Libor the highs and lows are thrown out, leaving the financial world with an approximation of what big banks pay to borrow from each other. When big banks actually trade with each other, however, they have to pay what they agree to with their creditors, not the Libor rates printed in the Wall Street Journal.

In 2008, Barclays was paying over Libor. The British government was helping it to cover its wobbly funding tracks in the interest of showing the financial world that London banks were solid and creditworthy.

Before this shell game, there was the another leg of the current scandal. From about 2005 onward, Barclays and others had been posting artificially high interbank borrowing costs, so that borrowers across the world would be paying higher benchmark rates on their loans and derivative contracts, valued in the trillions of dollars.

The reasons are easy to calculate. Imagine that the world’s big banks can borrow from each other at 2%, but that they secretly agree to establish a Libor benchmark rate of 2.5%. The fifty basis points are pure profit to anyone funding loans at 2%, and then charging a margin on top of 2.5%.

If true, Libor’s three-card Monte could have drained a reported $22 billion from unwitting borrowers. Nevertheless, while cabalistic traders were feathering their plush-carpeted nests, global regulators were also willing accomplices to the large banks in these rigged markets.

After the crash, institutions like the Bank of England and the Federal Reserve Bank were desperate to recapitalize the banking system. The presumed results would be to improve the profitability of the banks, and make them less dependent on state funding.

In fixing Libor, both high and low, Barclays probably thought it was doing the king’s bidding. No wonder its $39-million-a-year Chairman Bob Diamond expected a knighthood rather than a pillory.

If much of this finagling happened between 2005 and 2008, why are bankers now heading to jail for aiding and abetting their senior managements or the regulators? Why now the moral outrage, Senate hearings, presidential soundbites, indictments, hair shirts, resignations, and headlines that the banks have yet again stolen our money?

Although in theory banks are credit institutions, at least according to their charters, in reality they are political interest groups that occasionally grant loans.

Among the oldest arguments in American politics are those that center on whether the US should have national or just state banks, and whether the circulating currency should be tethered to some commodity (gold, silver, toasters) or allowed to float unhinged on world money markets, as they now do (Nixon ended the dollar’s convertibility in 1971).

Another divisive political argument has been whether banking and money should be beholden to big city interests (for example, robber baron J.P. Morgan) or to agricultural concerns (Andrew Jackson had them in mind). Morgan got rich on deflation when money was tied to gold; the farmers won with inflation because they could repay their loans with cheaper dollars.

In Europe, the similar divide is between the propertied and working classes. In the Libor scandal, Barclays is synonymous with the remittance men in the House of Lords, living off coupons.

Now on both continents, the political question is whether the financial system should be geared toward stimulus (cheaper money) or austerity (debt reduction; gold standards). In the US. election, Romney speaks for the hard money men while the Obama administration, like French President François Hollande, believes in fiat money with the revolutionary passions of Marat and Robespierre.

Because both political blocs have their constituents and henchmen, Libor bankers are walking the plank for constricting the money supply, and spendthrift politicians are being turned out of office, charged with debasing the paper currency.

Although the fine print of the outrage is obscure, Libor is at the subconscious center of the 2012 election and the future of Europe. No wonder headline writers and prosecutors are rounding up the usual banking suspects.

The soundbite storyboards are perfect for a prime-time, election-season docudrama, starring greedy bankers, virtuous senators, victimized home owners who were bilked out of billions in a scam hatched in City of London pubs and carried out in corner offices.

On the campaign trail the President could be heard to imply that plutocratic, Republican supporters of Mitt Romney are hand-in-black-glove with the rate fixers. The message is clear. The reason the world’s economies are in recession is not incompetent economic policies, but collusion between Wall Street and its UK counterpart, the City of London.

In other words, the banking system has fulfilled its historic political mandate: to give every presidential election “a good, safe menace,” so that nervous voters can cast their ballots to keep the moneychangers away from the temples of democracy, even though they need a billion in soft money to light the altar candles.

Flickr Photo by Garry Knight – The Dragon from the City of London's coat of arms, cast as a statue.

Matthew Stevenson, a contributing editor of Harper's Magazine, is the author of Remembering the Twentieth Century Limited, a collection of historical travel essays. His next book is Whistle-Stopping America.