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libor manipulation: who loses? June 27, 2012

Posted by Bradley in : financial regulation , trackback

A number of comments on Robert Peston’s story about the Barclays Libor/Euribor regulatory actions ask who lost out as a result of any manipulation of the rates. During the financial crisis the impact of any manipulation was to produce lower interest rates than those which would have been produced had accurate submissions been made (because the Libor quotes are supposed to reflect the quoting banks’ cost of funds higher rates suggest the market considers the bank to be riskier than lower rates would). It looks as though Barclays wasn’t the leader in submitting low rates in this period. In this period borrowers under existing Libor-based loans would be benefiting as they would be paying lower interest rates than they would had the quotes been accurate. The Justice Department Press Release seems to me to be a bit misleading here. It quotes Assistant Attorney General Breuer as saying:

Because mortgages, student loans, financial derivatives, and other financial products rely on LIBOR and EURIBOR as reference rates, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.

If Libor etc don’t actually reflect lenders’ cost of funds because the rate setting process manipulates the rates to a level lower than should apply, it is the lenders who suffer. So consumers suffer not because they are forced to pay higher rates than they should but because the inaccuracy of the rates means lenders are less willing to lend at prevailing rates, or suffer from financial distress because they are unable to make profits on their loans. And there are implications for interest rate swaps. But keeping Libor lower shouldn’t have had a negative impact on loan default rates. Would we all have been better off had the banks which quoted rates in the Libor/Euribor rate setting processes admitted publicly that they didn’t know what the rates should be? We’ll never know.

The manipulation to suit Barclays interest rate traders is different. Here the story is that agents of Barclays were manipulating the rates they quoted in order to allow individuals to make profits on their trading positions. And some of those making the requests for manipulation didn’t even work at Barclays, which implies that manipulation was carried out to benefit individuals rather than in the interests of Barclays. The suggestion that employees of financial firms were putting their own personal interests ahead of the interests of the firms that employed them, let alone the interests of the markets or of the taxpayers who would eventually be bailing them out, is what is most striking about this story.

For me this story justifies extreme scepticism of comments that financial firms make in the context of rule-makings about the need to ensure that regulation does not interfere in the operations of the financial markets (such as this comment by Barclays Capital on the Volcker rule proposal).

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