Big Rig? Libor & Beyond

BankstersTo inaugurate a series of posts about scandals and crime in the financial sector, I wanted to highlight John Lanchester’s work in the London Review of Books on “banks’ barely believable behaviour.” He mentions the still unwinding Libor scandal up front:

Libor is the single most important number in international financial markets, used as a reference point throughout the global financial system. It is a range of interbank lending rates, set after consultation between the British Bankers’ Association and two hundred and fifty-odd participating banks. During the daily process, each bank is asked the rate at which it could borrow money from other banks, ‘unsecured’ i.e. backed only by its own creditworthiness rather than by specific collateral. The question is, in effect: what would your credit be like today, if you had to ask? . . . .

It seems bizarre that something so central to the global markets – $360 trillion of deals are pinned to Libor – should have such a strong element of invention or guesswork. The potential for abuse is immediately apparent. As Donald MacKenzie prophetically said, ‘the obvious risk to the integrity of the calculation is that a bank on a Libor panel might make a manipulative input, trying to move Libor up or down so as to influence interest rates or the value of its swaps portfolio.’ Surprise! After the crisis, when investigators were taking an energetic interest in Libor, it turned out that that was exactly what had been happening, not just at one or two banks but across an entire swath of the industry.

Lanchester only brings up LIBOR as the opening act for what he considers a far deeper scandal in Britain—PPI. And guess what—it’s not just LIBOR where we’re seeing these concerns about privileged access to information turning into profit. Here are some other “rigging” scandals of recent vintage:

1) Swaps benchmark investigation.
2) Oil and biofuel manipulation investigation.
3) More energy market concerns.
4) Foreign exchange market described as a “wild west” featuring unfair manipulation.

One might be forgiven for thinking, along the lines of Matt Taibbi, that “everything’s rigged.” Of course, Very Serious People don’t have to respond to the concerns of a Taibbi, because he uses curse words. And we may soon see endowed chairs in finance departments mathemagically demonstrating that opportunities for manipulation merely incentivize individuals to create information, redounding to the overall benefit of society. But for those less enamored of theoclassical economics, critical questions arise. When do the violations of trust reach a critical mass such that our entire system of finance needs to be rethought? And how many more such incidents would we find if we adequately funded enforcement authorities?

Image Credit: dullhunk.

Frank Pasquale

Frank is Professor of Law at the University of Maryland. His research agenda focuses on challenges posed to information law by rapidly changing technology, particularly in the health care, internet, and finance industries.

Frank accepts comments via email, at pasqresearch@gmail.com. All comments emailed to pasqresearch@gmail.com may be posted here (in whole or in part), with or without attribution, either as "Dissents of the Day" or as parts of follow-up post(s). Please indicate in your comment whether or not you would like attribution, or would prefer your comment (if it is selected for posting) to be anonymous.

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2 Responses

  1. Ken Rhodes says:

    Frank, we rethought our entire system of finance (we being the USA) in 1933. The result, the Banking Act (popularly known as Glass-Steagall) and other related legislation, made banking very boring, but very stable, in our country for a long time.

    I have no idea whether England has similar legislation, or if they did what happened to it. I know what happened to ours.

    It’s a shame.

  2. Shag from Brookline says:

    This:

    ” … mathemagically demonstrating that opportunities for manipulation … ”

    is a huge needle in the banking haystack. Multiplying a few basis points times millions isn’t chump change. Frank, you should copyright this phrase to needle bankers even more.