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LIBOR Trickery Just the Tip of the Iceberg

We may be getting ahead of ourselves by declaring the LIBOR scandal a nonevent that wasn't costly for corporate borrowers.
Vincent Ryan, | US
July 12, 2012

Avert your eyes. Move on. Nothing to see here. That's what bankers would like to say to CFOs who are taken aback by the unearthing of the London Interbank Offered Rate manipulation scandal.

The preliminary ruling, at least from the point of view of the business press, is that the rigging of LIBOR by Barclays and maybe other banks did not harm nonfinancial businesses whose loans were priced based on the benchmark rate. Nor did it victimize companies that entered into interest-rate swaps to manage floating-rate debt liabilities. And really, with LIBOR numbers so small, finance chiefs care more about the LIBOR margin - can I get my bank to extend a line of credit at LIBOR plus 600 basis points instead of LIBOR plus 800 basis points?

But we may be getting ahead of ourselves by declaring this a nonevent. There is something worth looking at here. Bankers could have, indeed, profited from manipulating LIBOR, and at the expense of corporate borrowers. (See one example below.) In addition, the LIBOR manipulation scandal is a symptom of a larger problem - one that is costly for corporations.

By rigging LIBOR, here's the way bankers could have fleeced borrowers. The example is from a first-person confession in the British newspaper The Daily Telegraph, authored by an anonymous banker (not from Barclays). The banker says that during the financial crisis his bank used the lowballing of LIBOR to argue to corporate clients that the bank needed to raise the interest margins on their loans. Relationship managers were telling corporations in effect that LIBOR was not a credible basis for pricing risk - the term they used was that LIBOR was "dislocated from itself." Therefore, the bank's tale went, it had to increase the margin above LIBOR to realize any return on a company's loan.

t was true ­- LIBOR was an illusion. LIBOR isn't a free market rate; it's really just a benchmark for a generic bank's cost of funds, as ex-bankers have pointed out to me. But the bankers didn't disclose that they were helping to suppress the LIBOR rate by submitting a low, plainly false number, according to the Telegraph story. So here we have a bank clearly benefiting from LIBOR manipulation by duping corporate borrowers. I don't know if this story is true, and so far I haven't discovered if any banks in the U.S. were doing this, but this is truly damning stuff.

The point, however, is that this bank and others were violating what little trust still exists between bankers' and their clients. As columnist Reuben Daniels of EA Markets wrote in April, the universal banking model creates pervasive, unmanageable conflicts of interest in financial institutions that mix commercial and investment banking under one roof. Those conflicts are plainly evident in the LIBOR scandal. From a shareholder's perspective a bank does better when traders and the bankers submitting LIBOR numbers coordinate, Daniels says. But that's counter to how regulators and customers expect banks to operate, especially ones that are implicitly (still) backed by the U.S. government.

As Greg Smith, formerly of Goldman Sachs wrote in the The New York Times in March, banks like Goldman and Barclays operate in a culture ""where not a single minute is spent asking questions about how [they] can help clients. It's purely about how [they] can make the most possible money off of them."

But former bankers like Smith and Daniels don't blame the rank-and-file employees. The misaligned incentives inherent in the universal banking model are the cause. As a result of the questionable conduct around LIBOR rates, "there will be increased investigation, regulation, litigation, and fines," Daniels predicts. "But the problem is much deeper."