As most of America waited for the Supreme Court decision on Obamacare, and then reacted to its judicial transformation into Robertscare, the rest of the world was watching a major financial scandal unfold. It’s roots were in London, but Wall Street played a critical role.
The scandal surrounded LIBOR – the London InterBank Offered Rate. Since the mid 1980s, several major banks have been answering the following question from Reuters: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?” (Telegraph, UK). Reuters then drops the top four and bottom four rates, and averages the rest. The result is LIBOR.
At first, it might look like this version of a self-selected opinion poll, one ripe for manipulation and chicanery. In this case, the first impression is dead on. Up to 20 banks involved in setting the rate are under suspicion for fixing the rate (Daily Mail, UK). One bank, Barclay’s, has admitted to having a role in fudging the rate. More may follow.
In Britain, this is a major political scandal, as most of the rate fudging occurred under the previous Labour government. Strangely enough, no one is asking the more fundamental question: why is LIBOR still in use?
While everyone can acknowledge that a fudged rate is a problem – and that LIBOR is particularly prone to this sort of thing – we have to ask why this sort of thing is necessary when rates based on actual transactions are “on the offer.” Back to the Telegraph story:
At the same time, Libor’s importance has been undermined by other measures of lending costs, namely Eonia and Sonia, which track overnight swap rates and are based entirely on the actively traded market for interest rate swaps.
Supporters point out that Eonia and Sonia barely flickered when Lehman Brothers filed for bankruptcy in mid-September, having priced in for several months the funding problems of the banking sector. By contrast, Libor spiked before plummeting as central banks flooded the financial system with money.
Given that Libor’s spike was one of the panic triggers in Washington, it should be clear by now that this outdated indicator’s time has gone.