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The Libor Banking Fraud

Updated 28 August 2016. Created by janroe 3 August 2012.

This article examines what Libor is, how it is determined, what the scandal is about, and who benefited and lost out. It examines aspects of self-regulation in the financial and banking sector. The article offers information and opinion, but is not intended as actionable financial or legal advice.

If you had money in the bank, or a bank loan in the past few years, the Libor bank fraud could have affected you.

And this comes in the middle of a world recession caused by these same banks in 2007.

Underreported

At the same time, if you look at the news, this latest banking fraud scheme is going virtually unnoticed. Not sure if journalists find it too complicated, not newsworthy or believe it is beyond their readers or viewers? Or should be look for reasons elsewhere?

Looking into it more, this scam has massive implications that is sure to have cost and still is costing the general public, that is specifically you, me, and everyone else on this planet billions if not trillions of dollars, pounds and euros - all of which ended up at the banks as gazillions of profits. "This is a real zinger" an insider is quoted as saying. Why?

In the United States, in 2008, around 60 percent of prime adjustable rate mortgages and nearly all subprime mortgages were indexed to the US dollar Libor. In 2012, around 45 percent of prime adjustable rate mortgages and more than 80 percent of subprime mortgages were indexed to the Libor. American municipalities also borrowed around 75 percent of their money through financial products that were linked to the Libor.

Source: Wikipedia (see "Libor" at the bottom of the page). This is in the US. Libor affects the globe.

What is Libor?

Libor is the interest rate that global banks charge each other when they borrow money from each other. You might call it the "wholesale" interest rate among banks only, applicable for large amounts of money. They also call it the "inter-bank" lending rate.

The name "Libor" is an abbreviation for "London Interbank Offered Rate". This is not because Libor is restricted to London, but because these things are globally fixed there.

Who Uses Libor?

The banks. But it affects everyone else too. The Libor interest rate trickles down to all other financial institutions, while - as it happens in every supply chain - the cost (the interest rate) increases as your pecking order worsens. So the banks are likely to give mortgage lenders and credit card companies a rate that is higher than libor. Then of course end-customers get yet again another rate. This is all still perfectly normal in the prevailing financial system.

Interest Rates and the Money Supply Chain

First, each country's central bank sets a central bank rate which forms the basis of all other rates. This rate is a major macroeconomic tool that these central banks use to slow or spur an economy. The Alan Greenspan and Ben Bernanke thing.

The large banks are the first in the pecking order and receive this rate. Next, the first use within the supply chain is when large banks lend money to each other. They put a mark-up on it. The result is the Libor rate. Probably the next rate is the "Prime rate", the interest rate that banks charge large corporations. All other interest rates down the supply chain, right up to your loan and your investment, follow with growing interest rate that reflects cost, risk, and the need for profit at each step.

So Libor is the step right after Ben Bernanke. If someones messes with Libor, it has macroeconomic effect, meaning it affects everybody, including your mortgage, car loan and your investment.

Who Determines the Libor Rate?

The banks. Up to 1984 each bank set its own wholesale rate for lending to other banks independently, with their given central bank rate as basis. When the banks started to deal with a lot of new and complicated financial tools, they decided to get together and simplify things by stopping competition and fluctuation in the lending rates between banks. Since then, they jointly decide on a uniform wholesale rate, the Libor rate. This is now an accepted practice >> bbalibor™. Edit 31.12.2013: this website has reduced its visible content to a "disclaimer". Edit 18.11.2015: this website is replaced by >> bbalibor™ Libor practices apparently not mentioned.

This would be comparable to the price of meat being determined by the world butcher's association. This is obviously not the case, at least I hope it isn't.

Essentially, the setting of the Libor rate was in itself already an action defining a "cartel". Meaning a price fixing institution. This is prinicipally illegal. This has been, and remains an ongoing practice. But it is not the "scandal".

How is the Libor Rate Determined?

The bankers association surveys banks on daily basis with this exact question: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”. The bankers association took the answers, averaged them and established the daily Libor rate, meaning the banking cartel set its interest rates. This is still not yet the "scandal".

What is the Scandal?

On 27 June 2012 British and US authorities proved that a major bank, Barclays Bank had systematically lied about the Libor rate it had paid. The bank was fined and some people resigned. Nobody went to jail. It could only have done so in collusion with other banks. Current focus is on Bank of America, CitiGroup and Deutsche Bank. Likely there will be many more.

Why did they do it? Mainly, to increase profits or reduce losses in this banks' derivatives trading. Derivatives are directly tied to the Libor rate. If you can influence the Libor rate at will, you can make large profits or prevent losses in your daily derivatives trades. But Libor is likely to affect all other interest rates as well.

Here let me note that the scam not only involved Libor, which is for medium and longer term interbank borrowing, but also Euribor which covers short term borrowing and is determined similarly. The scam involved all inter-bank borrowing.

What did they do? They intentionally reported wrong interest rates for borrowing from other banks. Before the financial crisis of 2007/2008 it appears they reported lower or higher, according to their daily dealings. Starting with the crisis, they apparently generally reported lower than the actual interest they were paying. For example, if their interest rate was 3% they reported that it was 2%.

First question is, so what does it matter? And the answer is it does matter, significantly.

What's the Effect of Manipulating the Libor Rate?

Immediate Effect

The immediate effect, and possibly the lesser effect, was banks who manipulated the system made profits or averted losses on the scale of millions, tens of millions, hundreds of millions, possibly billions from illegally determined Libor rates. Of course what they gained, others lost.

Another immediate effect was banks who reported below actual rates, increase their standing and credibility within in the financial system. Other banks see a low reported Libor rate as a sign of the bank's strength and will be more confident to inter-bank lend to it.

Wide Effect

Let's look at the effects of banks illegally understating Libor, the general occurrence from 2007 onwards, while at times they appear to have overstated - with opposite effect.

The butchers buy meat from each other for 3$. Then they all get together and decide to tell everyone that they paid only 2$.

What's the effect on you? If you have meat, but you are not a butcher, your market price is based on $2. Further, everyone else's price is based on $2, while the actual market base is 3$.

The effect in the market place is that it illegally lowers interest rates for money. The banks illegally made money look cheaper than it actually was. It affected everyone's interest rate. And this has affected the value or everyone's money.

Note that a lot of financial products in the US have been and are based on Libor, but not all. If, and the likelihood is high, your bank's products and services have been based on Libor, this isn't peanuts:

  • You should probably have gotten a higher interest rate on your savings account than you actually received when banks reported Libor too low. This is because the Libor inter-bank interest rate affects all interest rates down the line.
  • Your and everyone else's investment or assets that had earnings related to the prevailing interest rates are likely to have been valued at or could be sold only at a rate that was lower than it actually was. This goes for any investor, for any interest rate based asset, worldwide.
  • The value of your house mortgage would could have been understated. A house mortgage with a fixed interest rate of 4% has a higher value when the current mortgage interest rate is 5%. In fact, you could have sold your loan at 4.7% and pocketed the difference (if the banks would allow this, but disingenuously they don't). But this is exactly what the banks do all the time, in very big numbers. And do note that the difference in monthly payments between 4% and 5% for a 30 year loan is significant.
  • Financial organisations down the line of the pecking order probably should have paid higher interest rates than they did. In turn they would have charged customers higher rates. Since their margin is based on those interest rates, a higher interest rate would have meant a higher margin and a higher profit. Everyone down the line lost out.
  • Everyone using derivatives, that is forward contracts, futures, options, warrants and swaps is likely to have been affected, especially those derivatives relating directly to interest rates. This includes a lot of municipalities and localities using derivatives that banks have increasingly peddled to them as a "source of income".
  • At times some investors may have come out ahead on some "deals". Some end customers with new loans may have had a gain. Those new borrowers paid less than they should have, when Libor was understated. - But now think back and present, hardly anybody has been getting new loans or has been refinanced. When the banks understate, they actually have to give out loans based on understated interest rate. Of course, they don't want to do that. Instant credit crunch?
  • Probably not all macro- and mesoeconomic effects, all of which have microeconomic consequences have been identified yet. Did the scam actually contribute to the credit crunch? Did the scam affect the recession, or its recovery? Did the scam affect public services? Budgets for education, police, fire departments?

To be quite frank, this is organised crime in the worst way. Do not be fooled by "News" that ignores this or puts it off as a storm in a tea cup. Do not be fooled by well-placed statements that such crimes are only small incidents and are of no consequence. Do not be fooled that the solution to the problem is simply fining the bank and allowing a few insiders and a multi-millionaire boss to simply retire on golden laurels. This is well-planned, organised, criminal activity. From the top down.

Free Market Self-Regulation Does Not Work

Apparently the banking system can't do without globally detrimental illegal activity on an almost daily basis. We need to understand that free market, private enterprise "self-regulated" systems simply do not work - the profit principle - profit above all else - always takes over. Even given the benefit of a doubt, taking the position that they work in the sense that they self-regulate after causing massive social and economic havoc - which as already happened - the sector is just at it again just like the good old times. No. Free market self-regulation does not work.

The Parable of the Self-Regulating Criminals

To reduce state regulations and save money, the free market system has decided to curb criminal activity by getting all criminals together and requesting them to form their own police force to guard themselves. After feigning initial hesitancy, the criminals agree to the proposal. You don't need to guess what will happen.

First of all, the criminal police force itself will function as a quasi internal government of criminals, its leaders will be the criminal elite that receives the bulk of income from all criminal activity. Its police force's members enjoy high status and profits that they will cling to at all cost. It's a closed society. Even so, they are interested to uphold the appearance that their police force works well.

In the meantime most criminals simply keep on doing what they do best, commit crime. The police force looks on, but exacts tribute. It stands guard and looks the other way or even participates while the criminals rob and maim you.

The victims cry out loud, but their pleas for help fall on deaf ears. With their vast profits the criminals have compromised the law abiding people's own police force, the journalists making the news, and the political body responsible for protecting the people.

As the house robbing, maiming and killing spree spirals higher, a scandal occurs. By mistake, a fellow criminal's house is robbed. He complains saying: hey, that's not fair! The fellow criminal is heard, because he is a member. The robbers pay a fine, return some of the stolen items, concede that a mistake was made and everyone concludes that the hitch responsible for this small mishap has been fixed.

This is now publicised as proof that the criminals' own police force is highly effective and much cheaper than keeping the criminals in prison. Then they return to business as usual and steal your house.

Source: janroe

Back to what we are talking about, this is exactly where the financial and banking system stands. A criminal system rules society.

Basics of What Needs to be Done:

The financial system needs to be strictly controlled by the government and its actions severely restricted to the essentials needed by the end consumer: Banks should be restricted to simple saving, simple borrowing and money transfer. Another type of organisation may be engaged in simple investing. None of these financial institutions should be allowed to have ownership ties with each other, or should in any (tricky) form be allowed to save, borrow, or invest on their own behalf using other people's money. All forms of highly leveraged high stakes financial gambling must be abolished.

The concepts of leverage and interest must be revised or discarded.

I'll be updating this note. For something slightly more positive, try bankers, and have a look below.

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Disclaimer: janroe is neither a financial adviser nor a legal adviser. This article is not intended as actionable financial or legal advice. For professional advice please consult an accredited professional financial service adviser or legal adviser.