The Central Fact of the LIBOR Rate Scandal
July 19, 2012
I begin with two charts.
First, the 1-month LIBOR rate.
Second, the 1-year LIBOR rate.
What do we see? First, they loosely parallel each other. Second, the move up began in late 2004.
What happened in 2004? The bubble in housing, all over the West. What caused this? Years of subsidized rates by central banks.
Why were rates low in 2002-4? Inflationary policies, led by Greenspan's Federal Reserve.
None of this should surprise anyone.
Then rates climbed. Why? The boom. There was greater demand for loans, because businesses were prospering. The real estate bubble grew.
Notice that the 1-month rate was slightly lower than the 1-year rate in late 2006. The yield curve was close to inverted. This is a warning sign of recession.
Let us look at American Treasury bill rates in this period. First, the 90-day rate.
It was a little over 5% in late 2006.
Look at the 1-year rate.
It was a little over 5% in late 2006.
In other words, rates were less than one percentage point higher in the LIBOR market for both short-term and 1-year debt. But these were privately issued IOUs, so the risk premium was higher. This is a normal spread.
Rates fell in 2008 in both markets. That was because of the recession. They kept falling through 2009. People sought safety. They went into short-term debt. This took place in all credit instruments.
Beginning in 2009, rates bottomed in both markets. They have stayed low. Why? Not QE2. Fear among bankers. They are keeping excess reserves in Europe and the USA. They do not lend to each other, because there is no demand for funds. Banks do not need to cover overnight. They have plenty of reserves at the central banks.
There is no sign that these two gigantic and interlinked credit markets were different in any significant sense over the entire decade. In other words, Barclays bank had no influence over rates. The banks that were involved rigged the system from 2005 to 2009.
Then what is the scandal all about? Ignorance of basic economics. What about the banks that manipulated the LIBOR rate? They made money on the margin, but they did not have any significant effect on these rates. You can see this in the LIBOR charts.
The scandal is a tempest in a teapot. No one lost much money. The banks did not keep rates lower than the market for more than a few hours -- maybe days, but I want to see proof.
The rates were governed by market forces.
The idea that Barclays kept rates down for years is ludicrous. No commercial bank can keep rates down if investors are willing to pay for a different allocation of capital than what the banks want. The bankers can make money at the margin, paying a little less for loans. But after 2008, none of this mattered. Bankers did not want to borrow from each other.
The appalling ignorance of basic economic theory is why we see the headlines about Barclays and the manipulation of rates. Bankers probably made many millions of pounds extra, but this had no measurable effect on the direction of interest rates. We are not talking about hundreds of billions. We are not talking about the Bank of England.
Columnists like to get attention. There is nothing like a scandal to get attention. But to say that the commercial banks manipulated inter-bank rates is saying that (1) central banks and reserve requirements don't count for much; (2) market rates can be held down by a few commercial banks, thereby overcoming the market for capital: lenders and borrowers.
The people who cry "scandal" do not think through the implications of what they are saying. Making a lot of money is one thing. It is possible. Re-structuring the derivatives market totaling about a quadrillion dollars in assets/promises is something else.
The problem has little to do with rate-tinkering by Barclays and the others. The problem, then as now, is the misguided Keynesianism that undergirds the policy decisions of the West's central bankers.
Keep Barclays. End the FED, the Bank of England, and the European Central Bank.