FT.com

Sometimes in life it feels sweet to say "I told you so”. This week is one such moment. Five long years ago, I first started trying to expose the darker underbelly of the Libor market, together with Financial Times colleagues such as Michael Mackenzie.

At the time, this sparked furious criticism from the British Bankers’ Association, as well as big banks such as Barclays; the word "scaremongering” was used. But now we know that, amid the blustering from the BBA, the reality was worse than we thought. As emails released by the UK Financial Services Authority show, some Barclays traders were engaged in a constant and pervasive attempt to rig the Libor market from 2006 on, with the encouragement of more senior managers. And the British bank may not have been alone.

No doubt some financiers would like to dismiss this as the work of a few rogue traders. And, in line with usual banking practice, the more junior authors of the incriminating emails have already been fired. But the wider symbolic significance of these revelations cannot be overstated; for they expose a big conceit at the very heart of the modern banking world.

Most notably, in recent decades large investment banks in the City of London and Wall Street have increasingly wrapped their activities with an evangelical adherence to the rhetoric of free markets; whenever they have wanted to justify sky-high profits, wacky innovations or, most recently, the need to prevent a new regulatory drive, they have invariably cited the ideals of Adam Smith.

But what the story of Libor shows is that this free market language has been honoured as much in the breach as the observance, to borrow Shakespeare’s phrase. And that was not just because a few Barclays traders were failing to "post honest prices”, as the emails admit. Instead, the real issue was that Libor was never organised as a proper market in the first place, which is precisely why the manipulation continued unchecked on such a wide scale for so long.

To understand this, think back to Smith’s own work. When the Scottish economist wrote his treatises more than three centuries ago, he lived in a world where business was dominated by small, family-owned firms. Smith took it for granted that in any market system the interests of owners and managers should be aligned, and these entities act within a wider social and moral framework. He also assumed two other ingredients should be in place: widespread, free participation in markets, and genuine price visibility. Without such open access, it is hard to have competition in a market economy, or the all-important ingredient of trust.

Many parts of the 21st century financial system display these attributes; public equity markets are (mostly) a case in point. However, in recent decades, the swaps sector has honoured these principles only patchily, at best. And in the case of Libor, the pricing was murky and capricious, since it was based on private reported quotes, not tangible deals. Moreover, the market has been dominated by a small clique of powerful banks, which also controlled the BBA. Owners of banks (ie shareholders) have had little chance of controlling the activities of these financial managers. Little wonder the group angrily brushed off criticisms in the past.

Reforming this system will not be easy. After all, one reason the BBA developed its peculiar price reporting system for Libor in the first place was that it was harder to use an open market system to set lending rates than trade equities. The task has become doubly difficult in recent years because parts of the interbank lending market have dried up.

And while some financial players are now trying to atone for this by turning to other benchmarks, such as the OIS, these are unlikely to replace Libor soon. After all, an estimated $350 trillion of derivatives contracts have already been written using Libor as a reference point, and about 90 per cent of US commercial and mortgage loans are thought to be linked to the index, too. That means that Libor – like credit ratings – is now hard-wired into the system, even with its flaws.

If nothing else, this week’s revelations show why it is right for British political figures, such as Alistair Darling, to call for a radical overhaul of the Libor system. They also show why British policy makers, and others, should not stop there. For the tale of Libor is not some rarity; on the contrary, there are plenty of other parts of the debt and derivatives world that remain opaque and clubby, and continue to breach those basic Smith principles – even as bank chief executives present themselves as champions of free markets. It is perhaps one of the great ironies and hypocrisies of our age; and a source of popular disgust that chief executives would now ignore at their peril.

Copyright The Financial Times 2012.

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This confirms two well known laws of the universe (Libor affair shows banking’s big conceit, June 29):
1. The last known free market was sighted in Tasmania in 1863. That is, it is a mythical animal that never existed even though many cults have sprung up in worship and quite a number of rituals are performed to honour its glory. These includes annual audits of "businesses" that exist as an infinite recursion of shelf companies in the Bahamas and elections which help determine which industries can get subsidies and tax concessions in order to remain as participants in the "free market".
2. Criminality only relates to sums of money smaller than the visible universe. When the numbers are larger than the number of atoms in existence at the time of the big bang (I'm pretty sure that number hasn't changed since) then things like fines and penalties are applied to infinite recursion companies registered in the Bahamas (see free market above). At worst, an individual's bonus could be suspended, sometimes returned but sackings are rarely applied when the level of fraud, deception and theft causes a stack overflow of a standard desk top calculator.
For amounts which can be stuffed down the front of one's trousers or shoved into the boot of a car, even if they are labelled as bonuses, in general, terms of incarceration apply.
I hope this is now clear.
When bankers start going to prison we will see a change in attitude (Libor affair shows banking’s big conceit, June 29).
Central banks are not descending on this because they are the root cause.
The Magic Pudding is alive and well. The printing of money without associated hard assets leads to unsustainable leverage.
Open up this rats sewer to the full view of the market. The Libor needs transparency. If rates are set too low and do not reflect risk, borrowers that should not borrow get access to funds they can never repay when asset prices fall. The system fails because of bad loans when assets can no longer be leveraged.
The worst loans are made at the top of a boom. The smart sell assets at the top, the stupid buy at the top. All ok if there is no borrowings involved or interest rates have increased to reflect the risk.
All this goes out the window when the printers hand out free money to create the boom.
Better to set a 5 per cent interest rate permanently. Unfortunately, its all too late for that now. The old empires slowly grind down, not by military defeats, but by internal cookery. The print their way to mediocrity.
Australia should set its bonds on the gold standard and charge interest on an Australian 10 year bond. Lend us your worthless paper so we can buy your property. If we cannot pay up we will back it with gold.
"...in line with usual banking practice, the more junior authors of the incriminating emails have already been fired"
They won't be leaving such trails in future - that does not mean that the rigging will stop - just that they will get away with it in future (Libor affair shows banking’s big conceit, June 29).
Some good points Geoff (June 29, 9.55am), although I would argue to set rates higher at around 6 per cent (Libor affair shows banking’s big conceit, June 29). Too late though, current policy is now just a blunt instrument.
A few questions. If Australian banks get 40 per cent of their funds for mortgages from overseas by borrowing from other banks has the manipulation of the LIBOR increased their costs? (Libor affair shows banking’s big conceit, June 29.)
And if so have AU mortgage rates been forced higher by these higher costs? And at what cost to the AU mortgage payers? Class action on the cards?
The public seem very keen jailing for fraud and collusion some of the big beans, to the extent that even the politicians are listening (Libor affair shows banking’s big conceit, June 29). This does of course effect all of us. The extra that went to the banks to when they pushed it up was effectively a tax on their customers, costing the real economy billions that they could binge on Bollinger. When they pushed it down, they cheated the stock market (and kept the value of their share allocations higher). While jailing a few CEOs with punitive clawbacks of bonuses to customers might raise the level of average honesty in banking industry, we really have to think very carefully about what this would do to the average level of corruption in prisons.
Funny stuff David Doyle (June 29, 9.45am). This goes to show that what is needed is true free market capitalism, not corporate/banking cronyism/corporatism (Libor affair shows banking’s big conceit, June 29).
A private banking market with no federal reserves/central banks with an ability to print your own money tied to gold/silver would fix it up.
(There was recently an excellent discussion on private central banks recently in the Daily Reckoning including debunking most protests against it).
Do Libor is rigged to suit the players? (Libor affair shows banking’s big conceit, June 29.)
What does that do to the Bank Bill Swap Rates that apply in Australia?
Is it all fine and beaut or is it time to buy shares in litigation funding outfits to benefit from the mass of (massive) class actions??
A recent example of a "free market" was yesterday's Roma Cattle Sale. There are plenty of other examples (Libor affair shows banking’s big conceit, June 29).
Re the Libor market manipulation, was it systematic? That is, did the supposed interventions make the rate higher than it otherwise would have been? If so, it benefited creditors. If it made the rate lower, then it benefited debtors. More likely, the interventions were non-systematic.