The Libor scandal and investor confidence

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What is the “Libor scandal” and what does it mean to you? The term “Libor” stands for “London Interbank Offered Rate” (no, it does not stand for Let’s Investigate Banksters’ Organised Rate-rigging…) and it is a benchmark commonly used to determine interest rates on business loans worldwide. The real impact on you and i, dear reader, is that all of this further erodes the confidence of an already shaken investing public. That makes safety seem more important than profit, and although this can be comforting in the short term, it is a wet blanket to long term profit, innovation and funding of the basic infrastructure needed in every community.

Bank fraud erodes investor confidence at all levels, and levies a cost on everyone

Bank fraud erodes investor confidence at all levels, and levies a cost on everyone (image source: liberalconspiracy.org)

So anything that erodes confidence in a fair and efficient market can be seen as detrimental to your personal financial well-being, even if you don’t invest into that market. Here’s a bit of information on just how hard some people have been working in an effort to achieve that end. Don’t let any of this deviate you from your own plans or take away the need to establish your own level of acceptable risk for achieving financial objectives. It’s simply a matter of being aware of what is happening in the financial world.

Libor scandal and rates

This one just may be the straw that breaks the back of the camel, and the one that will result in some action on the malfeasance in global banking circles. The GFC highlighted the difficulties in monitoring and regulating the super-large banking conglomerates, and now the Libor scandal is here to show us all just how far these large banks strayed from the straight line. It reads like some loopy conspiracy story – except that it is unfortunately very true, and the ramifications are bouncing around boardrooms right now.

To help gain some idea of the scale behind all of this, Morgan Stanley have projected eventual fines and damage payments of $22,000,000,000 for the banks involved.

Libor scandal and derivatives

The real money will be in determining whether the tinkering with Libor has provided advantage to traders in derivatives. Online news provider Spiegel International points out that the derivatives market has outstanding transactions of €567 trillion at the end of 2011 – many multiples larger than the sum total value of all the companies listed on all the exchanges of every country on the planet. Any movement in underlying rates that those contracts are traded on will have massive implications for participants.

Let’s see if we can work out just how sensitive a market that size would be to small movements (and let’s just play along with the idea that everything works simply in a market that is massively complex and theoretically a zero-sum game …). If we use good o’l Aussie dollars at today’s exchange rate, this figure comes in as $66,000,000,000 for one basis point of interest rate change. Put another way, even a movement as small as a 0.01% interest rate change gives a $66 billion dollar change somewhere or another… i know that this is oversimplifying things but it might help to put the anger and frustration around everything to do with the Libor scandal into some form of perspective.

Who’s linked to this particular scandal (taken from Spiegel International article here)?

  • Barclays Bank has been fined £290,000,000 for its part in the scandal
  • Barclays CEO Bob Diamond has been forced to resign
  • Paul Tucker – deputy governor of the Bank of England for suggesting rates were maybe too high…
  • US Federal Reserve Bank of New York – in 2008 a Barclays bank employee called to say the Libor rates “weren’t honest”. Even another call of the same nature triggered no alarm bells
  • British regulators – contacted by Barclays employees 13 times, to no effect
  • Timothy Geithner (US Treasury Secretary), who corresponded with the Bank of England to ask what what going on – but did nothing else
  • Bank of England Governor Mervyn King who didn’t even respond to Geithner’s first note and eventually replied that yes, something should be done to arrange to talk about it
  • RBS (Royal Bank of Scotland) expects “huge fines”, which will upset it’s taxpayer shareholders, and add to the angst caused when faulty computer systems stopped bank customers accessing their accounts with RBS, Natwest and Ulster Bank. Not exactly a confidence booster in a taxpayer owned bank.
  • 18 Banks in total, including Barclays, Credit Suisse, Deutsche Bank, WestLB and others… and that assumes the European version of Libor, which is calculated by an even larger poll of more banks again, is not involved in the same fraud.

So you can see that there are a lot of very powerful people currently staying back at work while the office shredder hums in the background (not that i would impinge on the good name of any of these folk or institutions because nobody is guilty of anything in a democracy until appropriate levels of proof of guilt have been put on display, pondered over and decided upon).

Of course, being linked to a scandal doesn’t mean you’ve participated or that you even noticed anything being astray. It’s more a matter of stating the obvious, and wondering whether anything will really come out of this other than fines on non-human institutions? There are hundreds of thousands of hard working, honest workers in these banks, and it would be incredibly unfair on them for the wrong-do’ers to continue in positions of power or control.

Spiegel graphic of Libor scandal

There are a lot of people involved in setting the London Interbank Interest Rate “Libor”

Taxpayer support in a Banking Crisis

A good deal of this chicanery would just be water under the bridge, and easily put aside for the latest news on celebrity gossip, fashion updates or sporting results in normal times – but these are not ‘normal’ times, and the banking industry is the global weak spot hurting the wealth accumulation, retirement and lifestyle decisions, and outcomes, of hundreds of millions of people.

Banks globally have been the recipients of trillions of dollars of taxpayer support, guarantees and subsidies from governments of just about every developed nation on earth. In such an environment, the banking industry is more prone than usual to accusations of cronyism, fraud, laxity or simply unfair play. In many cases, the people who supervised the banking industry throughout its pre-GFC joyride are the same people now benefitting from past or current taxpayer support, so it is difficult to see that anything has been learned from the awful conditions of the past 5 years.

Into this mire of boy’s club congratulatory back-slapping step a few whistleblowers exposing the Libor scandal. Not a good thing when you have concurrent discussion on the HSBC money-laundering scandal.

HSBC money laundering scandal

HSBC is Europe’s largest bank, and news has emerged of its US affiliates laundering billions of dollars of Mexican drug cartel cash, and helping some of the most violent and repressive people on the planet to happily play with their ill-gotten gains (if you are not aware of the activities of the Mexican drug cartels then i would consider you fortunate. Don’t even think of learning about it unless you have a strong stomach and a psychotic disrespect for human suffering).

HSBC has put aside $700m to deal with likely fines and costs associated with that little misdemeanour.

Market Malfunction?

It’s bad enough to worry about individual companies or sectors but what about the entire marketplace? Investor confidence gets chipped away a little bit at a time when we have disasters such as:

  • The May 2010 “flash-crash” that wiped $1 trillion from the US stockmarket in minutes, only to finish the day relatively unchanged. In the meanwhile, some eight S&P500 companies traded for 1c, while others traded for $100,000. Apparently, the judges are still out on just what caused it, and who is to blame.
  • In October 2011 MF Global failed at a cost of $1.6bilion to its creditors. MF Global was one of the primary dealers in its markets – in other words, a key player, and there are accusations that money was taken from client accounts to keep the firm afloat.
  • A month ago, the CEO of Peregrine Financial Group confessed to miappropriating $200 million of customer money to keep that company afloat.
  • This week Knight Capital Group lost $440 million in a day as a result of a computer glitch that sent their “High Frequency Trading” software into a splurge of ridiculous trades. That loss is greater than the market capitalisation of the company.

Australian has so far avoided this kind of melt-down. Maybe that’s partly a result of an on-the-ball banking regulator, and a reduced use of that high frequency trading software here compared to the USofA. Regardless, we have been quite lucky to have a stable and well-regulated sharemarket and banking system.

Is the glass half-full?

Strange as it may seem, i am quite pleased about these scandals. If they were not being exposed right now then the illegal activities would still be going on. Remember, these are not isolated events – these are systemic criminal acts by senior, otherwise-respectable pillars of the financial world, and they reduce the perceived value of the financial industry as a whole. For this reason, i’m hopeful that the exposure of these crimes will lead to even more diligence on the part of regulators, and maybe (just maybe) some sort of positive action by the politicians of the developed world to help get the banking industry stay on the straight-and-narrow.

Perhaps we should see this as a sign of a shake-up of the industry that nearly broke the foundations of our global finances, and a marker of a low-point from which a positive and enduring recovery can be made? It would be good to have a few positive stories about banks on the front page of our newspapers and on the screens of our tablets and smartphones, wouldn’t it?

It’s easy to forget that Australia has officially entered the record books for the longest recession-free run of any country, anywhere, anytime – 21 years! That’s half the averge person’s working life, and an incredibly good reason to be postive about the future. That run of strong output has allowed Australian’s to enjoy comparatively low unemployment, above inflation wages growth and a relatively stable house price market in the face of the biggest hit to global finances since the Great Depression.

Our glass is clearly half full.

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