by Stephen Tall on July 4, 2012
The Barclays rate-rigging scandal has conflated a number of issues — Bob Diamond’s bonus, ‘casino’ banking, failed regulators — making it hard to get behind the media’s shouty headlines to understand the issues which should really concern us. Here’s my brief show-your-working attempt, starting with what Barclays.
What Barclays did right: ‘fess up
LIBOR (London Inter Bank Offered Rate) is the rate at which banks in London lend money to each other for the short-term. It’s used as a proxy measure of market confidence in individual banks, as well as a benchmark for setting mortgage interest rates.
Barclays has admitted filing misleading figures for interbank borrowings they made between 2005 and 2009, and as a result been landed with a £290m fine. It’s unlikely Barclays were the only bank to attempt to rig LIBOR. But they are the first to admit it, as the investigating US department of justice’s statement made clear:
To the bank’s credit, Barclays also took a significant step toward accepting responsibility for its conduct by being the first institution to provide extensive and meaningful cooperation to the government. Its efforts have substantially assisted the Criminal Division in our ongoing investigation of individuals and other financial institutions in this matter … After government authorities began investigating allegations that banks had engaged in manipulation of benchmark interest rates, Barclays was the first bank to cooperate in a meaningful way in disclosing its conduct relating to LIBOR and EURIBOR.
It’s certainly true that Barclays’ cooperation resulted in a slightly reduced fine and the avoidance of corporate criminal prosecution (though employees were not granted immunity). But the bullet Barclays dodged there has ricocheted to hit its reputation squarely between the eyes. Barclays are now paying a heavy ‘first mover penalty’ as a result of the horrendous publicity they’ve attracted, exacerbated by the controversy over Bob Diamond’s infamous bonus payments.
What Barclays — and almost certainly other banks — did wrong: rate-rigging
There appear to be two distinct phases to their rate-rigging:
- 2005 to 2008: Barclays, sometimes working with traders at other banks, tried to influence the Libor rate – so as to try to boost their profits;
- 2007 to 2009: at the height of the global banking crisis, Barclays filed artificially low figures in an attempt to hide the level to which Barclays was under financial stress.
I think we can safely say the first of these is clearly bad and wrong, and quite possibly illegal.
There’s more controversy over the second, and in particular the suggestion that the government via the supposedly independent Bank of England ‘tipped the wink’ to Barclays to rate-rig at a time when the UK banking sector was teetering. It is alleged that Paul Tucker, the Bank of England’s deputy governor and top insider-contender for the top job when Sir Mervyn King steps down, phoned Bob Diamond in 2008…
… wanting to know why the estimated borrowing rates that Barclays fed into Libor calculations were relatively high. Mr Diamond said other banks declared rates lower than their real borrowing costs. Mr Tucker, who resembles a cerebral Winnie the Pooh, then allegedly implied that there would be no real harm in Barclays joining in. (FT.com, 3 July 2012)
At first glance the data is suggestive:
(Graph from FT.com, captured by @SuttonNick)
But Barclays is one of many banks whose rates are used to calculate LIBOR — any one bank’s impact on the overall LIBOR rate will be small. Yet as we can see, LIBOR fell markedly from the autumn of 2008, so Barclays were not outliers in lowering their rates:
(Graph from kshitij.com)
We have, therefore, one clear infringement by Barclays motivated by a desire to rig rates for profit (2005-08). We then have a further infringement by Barclays (and probably others) motivated it seems by a desire to shore up confidence in the banking system, perhaps with the implicit/explicit agreement of the Bank of England (2007-09).
When GOOD rate-rigging goes BAD
Motivation is a key point here. Rate-rigging for corporate profit is clearly bad. But what do we think about rate-rigging to prop up confidence in the banking sector? Is that also de facto bad?
Or is it better — or at any rate less bad — than the alternative, a collapse of confidence in banks and the freezing up of lending with all that implies for the economy?
I ask because rate-rigging with good intentions has been the policy of the UK government and Bank of England for many years. Jock Coats has drawn attention to former Bank of England governor Sir Edward George’s explicit admission of this in 2008:
“In the environment of global economic weakness at the beginning of this decade… external demand was declining and related to that, business investment was declining … We only had two alternative ways of sustaining demand and keeping the economy moving forward – one was public spending and the other was consumption. We knew that we were having to stimulate consumer spending. We knew we had pushed it up to levels which couldn’t possibly be sustained into the medium and long term. But for the time being, if we had not done that, the UK economy would have gone into recession just as the United States did.”
You won’t get a much simpler explanation than that of the current economic carnage. The government and the Bank initiated a short-term, well-intentioned aim of debt-fuelled stimulus (both individual and government) to prevent an economic downturn a decade ago.
They were then content to ignore the build-up of pressures in the economy that resulted, with the government’s instruction to the Bank of England to target retail inflation and to ignore asset price inflation allowing individual borrowing to let rip:
(Graph from Tim Morgan, The Quest for Renewal and Change (p.12), Centre for Policy Studies.)
Access to cheap-and-too-easy credit — fuelled in turn by ever-higher public spending — stoked an wholly artificial Ponzi-style economic boom which has now, inevitably, collapsed into a pile of rubble. The intentions of this rate-rigging were good, and never out of any desire for personal profit. But the consequences have been devastating, with individual and government debt continuing to weigh the economy down.