Fixing LIBOR

Last week Barclays Bank was fined close to $450m (£290m) by three government agencies for manipulating the benchmark level of market interest rates. This is a record fine for such a misdemeanour, although still very small in relation to the bank’s financial resources.[1] The affair has caused a furore in British media politics, adding to the populist anti-bank sentiment that ignores what is really going on. By manipulating the interest rates, Barclays was not ripping off consumers, it was questioning the ‘integrity’ of British-based international financial markets. That is a mortal sin, and that is why Prime Minister David Cameron and Bank of England governor Mervyn King are concerned.

The interest rates at issue were the London interbank offered rate (LIBOR) and the euro interbank offered rate (EURIBOR). The former is far more important, since it covers not only US dollars but also a range of other important international currencies, from UK sterling to the Japanese yen to Swiss francs, and also the euro. LIBOR measures the prevailing level of interest rates to borrow funds of different maturities from banks operating in London; EURIBOR is a comparable rate for euros only, and is set by banks operating throughout the euro area. While this may seem a technicality, it reflects the fact that the London international money market is the biggest in the world, and the location for the largest concentration of international banks. As noted before on this blog, this provides many important advantages for British imperialism, from the provision of cheap funds to a variety of revenues derived from surplus value produced in the global economy.[2]

For the British government, it is bad enough having to fight off the latest euro area plans for Europe-wide banking supervision and regulation, plans which threaten to cramp Britain’s room for manoeuvre and which could even raise barriers to London’s ability to penetrate European financial markets. Having the British-based financial system undermined internally is even worse. ‘Light regulation’ makes London attractive for global finance, but if it looks like the market is dishonest that undermines its status. In this game, the big players can, and do, act like monopolists, using their power to influence market prices. That is part of the game of being in imperialist finance. But they are not allowed to lie about the market prices that have been determined.

Barclays’ crime was therefore against principle. In terms of quantitative impact, the crime was nevertheless trivial. The FSA's report documents what happened, complete with hilarious citations from emails and internal communications that only serve to confirm that most traders are greedy, arrogant, irresponsible juveniles, rather than ‘masters of the universe’. However, it also makes clear that Barclays’ actions of pitching its rate above or below the market could have shifted interest rate settings by, at most, only one or two basis points (one basis point is one-hundredth of a percentage point). This is because the LIBOR setting was made from input from a panel of 16 banks. The official rate setting agency discarded the top four and bottom four rates received by banks, and then averaged the remaining eight.[3]

A couple of basis points higher or lower for the interest rate makes a measurable difference to the absolute level of interest payments on debt securities, on interest rate swaps, or to the net gain/loss on a futures or options position, when the value of these payments is already huge. Even then, for an interest rate level of, say, 5%, two basis points up or down will only change the annual interest paid by 0.4%. It is not a matter of concern for normal human beings, certainly not when compared to other issues in the economy. It is an issue for wholesale financial markets, where data for the first half of 2011 show that the notional amount outstanding of OTC interest rate derivatives contracts was $554 trillion, and that the total value of short term interest rate contracts traded on LIFFE in London in 2011 was 477 trillion euros, including over 241 trillion related to the three month EURIBOR futures contract. But even then, a higher or lower interest rate represents a gain for one party at the expense of another. Not everyone is a loser. In the case of Barclays, the evidence suggests that they were more often in the business of understating interest rate levels, both to benefit their own trading book and to give the impression that they were not finding it as difficult to secure funds as in reality they were. Hence, it is absurd to use this case as an example of banks exploiting mortgage holders. That is innumerate populism, not real analysis.

This case highlights an interesting feature of British critiques of the banking system. UK politicians, banking officials, journalists and media pundits can attack the greed of banks and the damage caused to the economy (usually meaning the national economy) by their actions. Some even think that the financial sector is, perhaps, a little too large, given that UK bank assets are five times UK GDP! But nobody wants to question the role of Britain’s own giant vampire squid in the global economy. People who get worked up about the Barclays interest rate scam are usually those who want imperialism’s financial system to work ‘properly’.

Tony Norfield, 2 July 2012

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[1] The UK Financial Services Authority (FSA) levied the lowest fine of £59.5m, a trivial amount for Barclays. The US regulator, the Commodity Futures Trading Commission (CFTC), levied a fine of $200m, the biggest it has ever issued and the fraud department of the US Justice Department's Criminal Division fined the bank $160m.

[2] See ‘The Economics of British Imperialism’, 22 May 2012. The latest data show the City gained net foreign revenues on financial services of £35bn in 2011.

[3] Even if Barclays’ low (high) quotations were discarded, this would still tend to have the effect of biasing the average for the remainder of the sample down (up). If a number of other banks also gave low (high) rate inputs, then there would be a bigger effect, but overall the banks would usually have offsetting positions and would not all be quoting with the same bias.