Monday, July 16, 2012

What to Make of the Libor Fiasco?

Firstly, what is LIBOR? Most people have never heard of it or care. (Rightly so, mind you, as most people put their trust in the people that administer such complex regimes on their behalf).

LIBOR is the London Interbank Offered Rate. It's basicly an interest rate market and one that has global significance. Every day around 11am London time, a group of participating banks get around a 'table' and decide what each would like to offer in the market for short term interest rates. A rate is then set and the banks charge each other this rate for short term borrowing, usually overnight.

The flow on effects of this rate are enormous. LIBOR is used to price many other financial derivatives; interest rate futures, swaps and Eurodollars. Now these instruments are for the hardiest of financial minds to understand. They mostly trade in the 'over the counter' market. A market far less opaque than it should be.

Anyway, the furour lately has been around the rate setting process. Those with huge derivative positions have been influencing some of the participating LIBOR banks into pushing their asking rates higher or lower depending on how the market is affecting them.  It appears from emails, that the banks (Barclays was one of the ones first caught) obliged willing to requests from commercial banks like JP Morgan.

The reason this incestuous relationship was harmful to Joe Sixpack, and anything he touched to do with banks, was that his interest rate could have been higher than would otherwise be expected because of this manipulation.  He paid the Piper for the sins of the banks; again. And the figures could run into the billions of dollars. Already many entities are preparing lawsuits.

The main lesson to take from this fiasco is that another significant amount of nails have been hammered into the coffin of the western monetary system. Institutions, like Banks, create the stability that we rely on to produce a sound, trustworthy climate in which business can be done according to contract and law. When trust and confidence in these institutuions eb away, we move closer to the precipice to chaos.

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