One of the permanent problems in writing about financial matters is that the issues at stake seem so technical, so arcane. It’s hard for any ordinary reader to get interested in these things. Hard not to think, Why does any of this matter to me?
The trouble is you probably thought the same about the sub prime mortgage market in 2007. It’s unlikely, in fact, that you even heard anything about that market at all, unless you happen to involved in finance. And if you did hear anything, you’d assume that the idiocies of Wall Street bankers lending to trailer-park types in Oakland was never, ever going to affect your life. And then 2008 happened. A global crisis. A massive recession. A wave of job losses. Pensions slashed, taxes raised, spending cut.
So technicalities matter. And here are a couple you really need to know about.
The idea you can trust the banks and the British Bankers Association is laughable
Number one, there is currently a storm brewing over the way LIBOR is calculated. That sentence, most likely, means nothing at all to you. What the heck is LIBOR and why would you care? Well, LIBOR stands for ‘London InterBank Offer Rate’ and is the interest rate at which banks lend to each other (plus or minus certain adjustments depending on the credit quality of different banks). That interest rate is the cornerstone of the entire financial system – more important, by far, than the Base Rate set by the Bank of England. If you don’t believe me, consider that $360 trillion worth of financial securities are priced off LIBOR interest rates. That’s about six times the GDP of the entire planet.
So LIBOR matters. And it’s being manipulated like crazy. Basically banks currently ‘estimate’ their cost of funds and an amalgam of those estimates is used to compute the overall measure. But because there are huge amounts of money atstake, banks have powerful incentives to provide ‘estimates’ that are strongly biased towards their own financial interests. And those interests are quiteunlikely to be the same as yours. Or, more candidly, they’re pretty much the opposite of yours.
Maybe this sounds to you like a cranky conspiracy theory. But just hear what others have to say. The US Justice Department is conducting a criminal investigation into the suspected manipulation of benchmark rates, of which LIBOR is by far the most prominent example. Regulators from Canada to Japan are also probing to see if banks have lied about their cost of borrowing. One fund manager, Tim Price at PFP Group, comments that ‘The idea you can trust the banks and [the British Bankers Association] with this is laughable.’
In dispute: LIBOR stands for ‘London InterBank Offer Rate’ and is the interest rate at which banks lend to each other
He’s right. It is laughable. And at the heart of this manipulation is a simple fact: huge, powerful, rich firms who pay their top earners enormous amounts of money are willing to lie to suit their own ends. Not once. Not as a one-off response to some extreme pressure. But day after day after day. For their interests, not yours.
The surge of interest by regulators is something that I profoundly welcome. Youjust have to wonder why it’s come so late. Almost ten years ago now, I developed a financial index for the energy trading industry which has never once beenmanipulated. Which can’t bemanipulated, because it’s got anti-cheat measures built into it. That same technology could be adapted for the LIBOR measure. Something like it could have been put in place ten years ago. Or now. It could be compulsory by the end of the year. So why isn’t it?
And here’s where you get to the really sad part of the story, which is that regulators are on the banks’ side more than they’re on yours. Take the famous ‘stress tests’ imposed on the banking system by regulators in Britain, Europe and (now) in the US. They sound like such a great idea in theory and in practice … oh dear.
Banks will go on manipulating things, regulators will go on regulating with all the force and aggression of a wet sponge
Belgian bank Dexia sailed through its European stress tests. No problems. All tickety-boo. Everything shipshape and Bristol fashion. Unfortunately, far from being one of the safest banks in Europe, as those stress tests claimed, Dexia was in terrible shape. It is currently in the midst of an (incredibly expensive) government backed reorganisation.
The moral? Well, two morals really. The first is that technicalities matter, even when they can seem arcane. The second, that truth matters. And because we can’t rely on banks to be truthful, or regulators to regulate, we also need totaltransparency. Truth we can trust.
Until we have that truth, banks will go on manipulating things, regulators will go omn regulating with all the force and aggression of a wet sponge. And you will go on losing out in ways you can hardly even understand.