The days between the Fourth of July and Bastille Day on the 14th are known for fireworks on both sides of the Atlantic. This year, more rockets and firecrackers than usual were going off, but they were inside hearing rooms in the British Parliament and the U.S. Congress. Barclays bank announced that it had been fined more than $450 million by regulators from both countries, and its CEO, Robert E. Diamond Jr., and COO, Jerry del Missier, both resigned. The fines were part of a settlement that granted Barclays immunity from potentially worse punishment for its manipulation of interest rates. The press reported that 10 to 12 other large banks (including HSBC, Citigroup, and JPMorgan Chase) were also under investigation.
The big financial scandal of July 2012, or at least its first half, involves manipulation of the London Interbank Offered Rate, or LIBOR. The press has used a variety of estimates of the impact of LIBOR, ranging as high as $500 trillion (the Bank of England estimate) to $800 trillion in loans, securities, and derivatives that are linked to the LIBOR index. (For perspective, the 2011 gross domestic product of the entire globe was only $70 trillion, according to the World Bank.) These estimates may well be vastly understated, because they appear to exclude the huge currency markets (with turnover of $3 trillion to $4 trillion per day). The difference in value between U.S. dollars and euros is largely a function of the difference between dollar LIBOR and euro LIBOR, though the effect is not explicit as in a loan indexed to LIBOR.
Whatever calculations are used, the numbers are simply staggering. LIBOR represents the cost of money. It affects mortgages and credit cards as well as corporate bonds and loans since interest rates are almost all pegged to LIBOR.
The financial world is seeking to place blame in the LIBOR scandal to divert attention away from the bad behavior of the banks. Their spin managers will want to make the proceedings and the media coverage into a discussion of regulatory failures. There is little doubt that regulators were both inattentive and complicit, and a thorough investigation of their failures is in order. However, regulators did not manipulate LIBOR; banks did. Their culpability and schemes to deceive the markets and the public must not be obscured by the search for what regulators knew and when they knew it.
Barclays and other banks manipulated LIBOR in two distinct ways. First, they engaged in price rigging—biasing the daily LIBOR index either higher or lower and simultaneously colluding with traders to turn a profit on the prior knowledge of the bias. This activity was fundamentally larcenous, and Barclays settled its liability to avoid further punishment for defrauding the market by rigging prices.
The second thing they did involved more nuanced moral choices. As Barclays struggled to survive, it reported interest rates on its borrowings in the LIBOR process that suggested that the bank was less fragile than it was (a practice known as “dressing up bank credit”). This dishonesty must be viewed through the filter of an organization that fears its mortality. Since it was undertaken to mitigate the day-to-day perceptions of bank soundness in the midst of the crisis, it was not necessarily a behavior that would be repeated. It is likely that management justified it as a step to calm a panic. While wrong, it was somewhat less reprehensible than the trading scheme.
But both the price rigging and the reports on the interest rates were massive deceptions on the public. The banks and the individual employees that engaged in the practices may well face criminal penalties if the ongoing Department of Justice inquiry bears fruit beyond the Barclays settlement. The Justice Department has been working alongside U.S. regulators for two years to investigate the manipulation of interest rates.
