The WAPO Misexplains the LIBOR Scandal to You

In a piece that has the word "explainer" in its headline, the post proceeds to mis-explain the LIBOR scandal to its readers. The second paragraph tells readers:

"This is a big deal. Remember that JP Morgan scandal a few months back? That was mostly JP Morgan hurting itself. The LIBOR scandal was Barclay’s making money by hurting you."

The claim is that LIBOR liars cost people money by inflating the LIBOR rate, thereby causing people to pay more on mortgages, car loans and other debts that were tied to the LIBOR. The problem with this claim is that there is no evidence that the mis-reported LIBOR rates had an upward bias. In fact during the financial crisis they were understating the true rate.

This means on average, there is no reason to believe that people paid more on their loans because of the lies than they would have in an honest market. Some people undoubtedly did pay slightly more, but others paid slightly less. And, since the direction of the lies was systematically downward in the crisis period, consumers may have actually benefited from this scam.

The LIBOR scandal is primarily about bankers ripping each other off by using false information to make their trades winners. The bankers deserve to go to jail for this fraud, but their main victims were other traders.

The public did lose in this story but the loss is primarily from resources being devoted to game playing and nonsense in the financial sector which instead could have been devoted to building up the economy. In this sense, the financial sector can be thought of as the equivalent of a massive government agency devoted to promulgating waste, fraud and abuse. The money used to fund this department would be a pointless drag on the economy, just like our bloated financial sector.

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written by ltr, July 07, 2012 10:48

This explanation makes no sense at all.

-2

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written by fuller schmidt, July 07, 2012 5:12

I read that the cost of cheating lower on the Libor was to those who were on the wrong side of interest rate swaps, largely municipalities and for substantial amounts. The article did get fuzzier as it went on though.

Lossers
written by James, July 08, 2012 2:58

How about local community banks that tied some of their loan products to LIBOR; therefore, their yield was lower than could have been which resulted in lower income and capital exposing themselves to have lower cushion to protect against the declining assets quality that were going on during the housing and commercial RE collapse.

Even if those banks survived, their lower level of earnings and capital could have increased their deposit insurance premimum to the FDIC.

http://www.disequilibria.com/blog
written by RueTheDay, July 08, 2012 8:00

Why exactly are municipalities entering into trillions of dollars (notional) in interest rate swaps after issuing variable rate securities instead of just issuing fixed rate bonds in the first place?

I'm sure the answer will be something like "because they can get an interest rate xx basis points lower by doing it that way and save a fortune in interest expenses" or something similar. Did no one bother to ask "How is it that even after accounting for the banks' fees we are still able to get an even lower rate? Are we perhaps letting the lenders shift additional risk onto us in exchange for that lower rate?"

LIBOR- Manipulation of this rate is a problem.
written by scott moore, July 16, 2012 12:28

“LIBOR is the interest rate which banks in London borrow and lend to each other.” (Grinblatt & Titman, 1998). LIBOR rates are based on AA and AAA quality bonds, considered almost riskless. This is important, for when valuing almost anything in the financial world, the analyst needs to use a risk free rate in part to estimate debt financing cash flows. Most use LIBOR versus United States Treasury bills.

For any debt financing, in order to calculate the return of a financial instrument the analyst needs to calculate the future cash flows. Debt market players know that an interest rate will float within a range. LIBOR is used in the formula to calculate the floor. An informed analysis is able to determine the cash flows which make up LIBOR. With this knowledge, along with spread and risk estimates, an analyst can create a cash flow analysis for a particular dept instrument.

When recently it came to light that the LIBOR rate was manipulated, this may have technically only affected banks, but as noted above there are far reaching implications, since the manipulated rates were used as part of a calculation to determine cash flows debt financing on different financial instruments around the world. By manipulating LIBOR, it has added a question mark as to the boundaries of riskless and begs the question,"is the interest rate I am paying correct or not"?

The WAPO Misexplains the LIBOR Scandal to You

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