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LIBOR Manipulation is a Scandal, But Not the Right Scandal

System Failure

by ROB URIE

Bankers are losing their jobs and the financial press is up in arms over the manipulation of a key interest rate, LIBOR (London Inter Bank Offer Rate). The manipulation is a big deal because of how large of an effect LIBOR has– $750 trillion of Swaps (notional) is outstanding and most of it is priced to LIBOR. Additionally, another very large amount of loans have interest rates based on LIBOR. So manipulation of the interest rate shifts a very large amount of money from one group of people to another.

For a sense of the size of the problem, the goods and services the U.S. economy produces in a year are worth around $16 trillion. So the idea of $750 trillion in securities being manipulated is nearly beyond comprehension. But consider this: (1) most of the $750 trillion in Swaps (notional) outstanding were issued after the financial crisis in 2008 and (2) most financial markets are already being ‘managed’ meaning that manipulation of prices is the rule, not the exception.

Swaps are used to trade one financial return for another. Swaps notional is a scalar, a fictional value used to scale payment calculations, not a dollar amount at risk. The actual dollar amount at risk is the summed difference between these returns over some period of time. The manipulation of LIBOR produces gains for one group at the expense of another. Manipulating LIBOR is straightforwardly theft. And given the scale and that banks and bankers are the culprits, this interest rate manipulation is organized crime on a massive scale.

However, the existence of the Swaps market already was a scandal. The Swaps market is OTC (over-the-counter), meaning by design there already was little price transparency for Swaps. If a Swaps dealer can set the price that they pay (or receive) a bit lower (higher) without the purchaser knowing it, because there is no price transparency, the market has already been manipulated. Manipulating LIBOR in addition just adds insult to injury.

The Swaps market would be relatively easy to put onto a securities exchange. Doing so would provide price transparency and the potential for regulatory oversight. But Wall Street, with the help of current and former Obama administration officials, has lobbied furiously to keep Swaps off of exchanges because the banks don’t want price transparency. The banks profit from having information that their customers don’t have. This $750 trillion game was already rigged before the LIBOR scandal.

Even if the total dollar amount at risk from Swaps is less than $750 trillion, it is still in the tens, if not hundreds, of trillions of dollars. This is risk that the banks took on after the financial crisis of 2008 that saw them bailed out with trillions of dollars in public money. Credit Default Swaps (CDS) were the reason for the $160 billion bailout of AIG. This market will be the most likely culprit to bring down the global financial system when it inevitably moves back into crisis. The continued existence of the Swaps market after 2008 dwarfs LIBOR manipulation as a scandal.

For the uninitiated, price manipulation, be it interest rates or stock prices, is the only thing keeping Wall Street alive. The entire business of the Federal Reserve is to ‘manipulate’ interest rates and the money supply for the purported benefit of ‘the economy.’ This isn’t to accuse the Fed of wrongdoing, given the economic premises behind their actions. But (1) changing interest rates as the Fed does benefits one group at the expense of another and (2) the beneficiaries just happen to disproportionately be the already rich and powerful. And the banks eternally benefit from Fed actions. The Fed works for, and is run by, the banks. So also does the Western political system.

With respect to current interest rates, the reason that the Fed is keeping interest rates low (manipulating them), and will continue to do so for a decade or more to come, is to prevent adjustable rate mortgage holders from defaulting on their home mortgages at further expense to the banks. The nonsense about doing so to ‘spur lending’ runs into (1) the existing excess of private credit, (2) the dearth of credit worthy borrowers among those needing loans due to the ongoing economic depression and (3) that large corporate borrowers already have access to as much credit as they desire through the capital markets. Additionally, banks profit from cheap credit because to the extent that they do make loans, they lend at a higher rate than they borrow at.

The claim the Fed has been manipulating global stock markets higher for the benefit of the already rich that own all of the stock is not controversial. Fed Chairman Ben Bernanke has publicly proclaimed this goal and has explained the mechanism that the Fed is using to do so, the ‘portfolio balance channel.’ This represents a transfer of wealth from a quasi-public entity, the Fed, to rich, powerful interests through the manipulation of financial market prices. Should readers buy the Fed’s explanation that manipulating stock prices higher is for the public good, please look into who owns stocks. Sorry to break this news, but the Koch brothers’ interests and yours are not the same.

Last, with all of the hand wringing over ‘austerity’ policies in Europe and the U.S., austerity economics are banker economics and have been for a few centuries. Austerity causes disinflation or deflation, meaning that the accompanying social disasters– unemployment, poverty, homelessness, and permanent debt servitude benefits bankers because they see loans repaid in more valuable dollars. With austerity policies to benefit bankers ruling the day, why is this not the ‘scandal of the century?’

For those who wish to be constructive toward the existing political economy, the number of criminal prosecutions that could be brought against the banks is nearly infinite. This has been known is some detail since 2008. Barack Obama has done everything in his power to assure that no criminal investigations occur. Mitt Romney would do the same.

So, if I may, the system is the problem, and not this banking scandal or that.

Rob Urie is an artist and political economist in New York.