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Let LIBOR lie

The LIBOR manipulations show incredible hubris but little else.  In the world of finance, prices and rates rarely prove stable for long and unlike The Great Recession, the larger effects of these particular financial happenings appear negligible.

LIBOR, the price one bank charges another on a loan, is important for reasons similar to prices in a stock exchange.  Both prices are “indicators,” providing a reference point to understand general happenings.  Since a price is an aggregation of all the people willing to make a purchase, the list price is not some single, immutable value.

However, it is easy to find meaning in the stock market’s daily fluctuations, especially now that massive amounts of money can move with a pushed button and the tickers on most news broadcasts report any change as it happens.  Analysts and prudent investors know that the long-term trends provide the real information.  The daily net change provides more information about human dynamics than a company’s value.

LIBOR is similar: a jump or fall in the rate one day doesn’t necessarily mean that banks overalls have lost or gained confidence in one another.  Only extended patterns of behavior indicate the relative confidence within the banking sector.

Ignoring the macroeconomy, on the micro level a change can matter greatly to an individual.  In finance there are ways to make money off of anything, including a change that happens one time on one day.  For example, a price change to a single stock won’t predict a recession or herald a GDP gain but it can mean a very nice Christmas bonus.  Similarly, as a Bloomberg article points out, a small change to LIBOR of .002% can mean a quarter of a million gain to a trader on a $50 billion position.

It is clear that people manipulated LIBOR.  It is also clear that despite manipulations, LIBOR over the longer term did indicate that banks were losing confidence in one another, which can indicate a recession.  Despite the fiddling about, LIBOR managed to do its job.

Suppose no one had manipulated LIBOR  and that it indicated in no uncertain terms an imminent recession.  With action comes political and economic risk.  Action to prevent a crisis when no crisis ultimately occurs could mean that action was unnecessary.  Action and then a crisis could mean that the action caused the crisis.  Meanwhile, knowing a recession will likely occur could induce panic, guaranteeing a recession and sooner.

LIBOR does affect, as a Parisian advisor to the OECD said, “every derivative known to man.”  Remember, though, that derivatives were not brought down from Mount Sinai, nor did they originate in the primordial slime alongside our ancestors.  Man created derivatives, just as he created LIBOR and he decided to use LIBOR to calculate derivatives.  Besides frescoes on chapel ceilings,  it is understood and expected that people will alter their initial product.

But unlike a change to Facebook’s privacy settings, people cannot really chose  to accept or reject LIBOR;  the rate will affect the price people pay on loans.  However, the past decade has seen very lenient loan terms and levels of consumer debt without historical precedent.  If a LIBOR manipulation meant people paid more on loans, the effects were negligible.

If LIBOR was kept artificially low, motivating more debt, that is not necessarily bad.  People chose debt and the choices available improved: no debt or debt at a lower cost are much better options than no debt or debt at a higher cost.  More importantly, t debt allows people to do things that they couldn’t otherwise, like finance a home, education, or business.  More favorable terms means more of those benefits.

It seems highly unlikely that manipulating LIBOR could cause bankruptcy or foreclosure.  Individual problems happen most often when someone can no longer meet payments or signed a loan without realizing that the interest rate would eventually jump unsustainably.  And while a small manipulation can mean a seemingly big gain or loss, a big change comes only from an even larger position.  ln the example cited earlier, the $250,000 gain is the equivalent of .005% of the $50 billion.

Notably, it does not appear that any bank went out of business due to losses from a manipulated LIBOR nor do we see massive policy changes between Friday night and Monday morning as during the financial crisis.  Has there even been an attempt to occupy the footsie (FTSE)?  The lawsuits have an insisting tone that somebody pay for the collective willingness to lie and tolerate lies.  And if $1.6 billion is the penalty, then, compared to the size of balance sheets, it seems that trust is less of an asset than a collection of derivatives.



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