Lessons from Libor: Sometimes even the truth can hurt us!

Here we go again – yet another scandal suggesting that the whole banking system is rotten to the core!  But this time I suspect it is different.  Unlike insider dealing, sub-prime lending, payment protection insurance and interest-rate swap miss-selling, the Libor rate fixing scandal uncovered at Barclays is likely to involve a lies, deception and half-truths that extends far beyond the boundaries of a single company.

The Coalition and Labour front-bench argument over what sort of enquiry would be best reminded me of the maxim: ‘be careful what you wish for, it might come true’.

While getting to the truth is generally a good thing, in this case I fear that the righteous quest for truth may open a Pandora’s Box, the consequences of which could be damaging for everyone.

During the Leverson Enquiry we have seen how relentless questioning can move an enquiry from its original brief into wholly unanticipated areas.  In this case the enquiry was established following the public outrage at the hacking by journalists of the phones of celebrities, politicians and members of the public.  But as one question led to another the enquiry has more recently concentrated on the murky relationship between politicians and the media, with the relationship between the Prime Minister and senior members of the Murdock media empire becoming a particular area of focus.  I am sure that David Cameron did not anticipate this occurring when he announced the enquiry in July 2011, and it is probably the reason he has resisted Labour calls for a similar judicial enquiry into the Libor fixing scandal.

However, while I am sure that none of us are worried about the embarrassment an enquiry could cause for politicians; there is a concern that it could stray into areas where the boundaries between right and wrong are unclear and where exposing the truth could be potentially damaging to us all.

For example, when Bob Diamond, the ex-CEO of Barclays Bank, appeared before a Commons Select Committee the other day to answer questions on Libor rate fixing, he made it perfectly clear that he was not willing to be the sole victim of the scandal.  The reality is that the institutions of banks, governments and even whole economies are so interwoven that it is difficult to separate one from another.  When the Libor fixing story broke the implication was that banks were bidding the rate up in order to increase their profit margins.  But within days the story has broadened to include a conversation between Barclays and the Deputy Governor of the Bank of England on the 29th October 2008 during which Bob Diamond alleges that Paul Tucker, Deputy Governor of the BoE, passed on concerns from Whitehall about Barclays’ Libor submissions, adding that “it did not always need to be the case that we appeared as high as we have recently”.

But why all the fuss and what is Libor anyway?

Libor stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from each other.  The rate is set by the British Banking Association who, in conjunction with Reuters, collect submissions from each of the major banks on the rates they are able to borrow money from one another at and they then publish the Libor rate shortly after 11 am each day. 

Libor is therefore best described as being the wholesale price of money.  Declaring a Libor rate above the rate at which a bank can actually borrow at enables it to justify increasing its retail prices, thereby inflating its profit margins.  Although any one bank can only have a minor impact on the overall rate, Libor has become so important in the global economy that the sums of money involved are so large that even a small movement in the rate can have huge implications.  For example, Professor Andrew Lo of the Massachusetts Institute of Technology’s Sloan School of Management recently estimated that a 0.01% change in rate could result in a $90 billion error.  As Professor Lo said; “That kind of money dwarfs all of the financial scams in history”!

The scale of the money involved makes it inconceivable that central banks and governments will not be involved at one level or another.  Indeed, this is the inference from Mr Diamond who believed, whether correctly or not, that the comments of the Deputy Governor of the BoE were intended to imply that unless Barclays lowered their Libor rate submissions there was a risk that Whitehall might assume they were finding it difficult to borrow money and therefore step in with a nationalisation plan as they had done with RBS, Lloyds and others.

The irony is that governments are already involved in the ostensibly legitimate manipulation of financial rates.  They do this through the fixing of the Base Rate, through ‘quantitative easing’ and through the manipulation of exchange rates by buying and selling currencies on international markets.

The fact is that all of this activity, whether legitimate or not, has implications for each and every one of us.  Whether it is the interest rate on the credit card bill, the amount we pay for the mortgage or the cost of the foreign currency we buy to take on holiday, all have been manipulated by forces other than the ‘free market’.  And as in all walks of life, there will have been both winners and losers; some will have benefited from these shenanigans while other will have lost.

But the sad thing is that we will all suffer as a result of the Libor fixing scandal.  Strong financial institutions are an essential element in a successful economy as they instil confidence and facilitate the free movement of money, goods and services.  Any disruption to that process or reputation results in a weakening currency and higher prices.

In this particular scandal I believe the implications will be nowhere near as painful as they arguably should be.  The reason is that I suspect the problem affects most major institutions around the world and that very few governments would emerge with their reputations unimpugned if the scandal were investigated fully.

A more likely outcome is that governments will investigate the issue, a few senior people will be made scape-goats and get fired and a few law suits from groups seeking compensation will rumble on for years.
And for the rest of us life will continue as normal, with, as Benjamin Franklin once wrote, the only certainties being death and taxes!

PS - The image attached to this article was sent to me in an email and is presumably doctored

About the Author
Alistair Schofield is Managing Director of Extensor Limited.