Who suffers from playing games with LIBOR?

Earlier post discussed the blooming scandal over LIBOR rates.

Short version – Barclays has admitted it underreported borrowing costs which in turn affected the LIBOR rate, which is the base for calculating the interest rate on many loans.

The populist-type comments I’ve seen so far suggest that consumers are being ripped off. 

I don’t think so. Consumers aren’t the ones who suffer.  Here’s why:

If the gargantuan banks are underreporting their borrowing costs that means LIBOR is lower than it should be, which means interest rates that consumers and businesses are paying on their loans are lower than they should be. In other words, consumers and businesses with debt tied to LIBOR are getting a break.

(By the way, the news coverage now suggests that it’s more than just Barclays that was underreporting their borrowing costs. That is why we should start paying attention, because if correct, this issue is going to expand widely and rapidly.)

If consumers aren’t the ones suffering, then so what?

Every loan has two sides. If consumers are underpaying compared to what the real LIBOR would have been if reported correctly, then their creditors are forgoing interest income. That means that smaller banks who hold loans tied to LIBOR along with pension funds, insurance companies, and anyone else who loaned money based on LIBOR has been shortchanged.

The lenders got shortchanged by Barclays.

Loss of trust may be the bigger casualty. Or rather increasing loss of trust.

The more serious issue is that this will play into the lack of trust many people have for large financial institutions, especially the huge banks. The populist play will be “they are just ripping us off”, even though consumers got a break on their interest payments.

There will be serious political backlash, which has already started in England.

Perhaps the worst thing would be if smaller-than-money-center banks, pension funds, and insurance companies come to the conclusion that “they are just ripping us off.” That would be very bad.

Did the regulators know all along?

The articles I mentioned in the earlier post contain some comments that Barclays told the regulators that other banks seemed to be misreporting their borrowing costs. At first glance, this looks like the “everybody is doing it” defense.  Let’s look a bit deeper.

An article editorial in the Wall Street Journal, Barclays Bank Bash, (behind paywall) explains Barclays told multiple regulators of their concern:

Several times in 2007 and 2008 Barclays employees reported that large banks, to make themselves appear healthier than they were, claimed to be able to borrow at rates lower than the market was offering them. These communications from Barclays were directed to the Bank of England, the British Bankers Association and the Financial Services Authority in the U.K., and to the U.S. Federal Reserve Bank of New York, then run by Timothy Geithner.

So the Bank of England, BBA, UK FSA, and NY FRB had multiple tips in 2007 and 2008.

By the way, this isn’t a new issue. The WSJ has been reporting on problems in LIBOR for a long time. I haven’t looked up the articles, but do recall having seen articles for a while. (Update:  The WSJ says they first reported on problems with Libor in 2008.)

Stay tuned. I’m sure we will hear more.

Update:  At lunch today I read two more articles in the Wall Street Journal. My knowledge of the Libor mess is growing at an exponential rate. I thing the scandal is growing at an even faster rate.  That worries me.

My comments above were based on my understanding that the manipulation was limited to roughly the time of the fall 2008 financial crisis. If that were the case, then the damage would be to investors holding paper with interest rates based on LIBOR.

It now looks like the rate fixing was going on before the financial crisis and continued after.  If that is the case, then there is a financial benefit to Barclays and the other banks who were playing games with the rate. Who would be damaged then? I’m not so sure of the answer to that.

More discussion to follow!