The Wall Street Scandal of all Scandals

Just when you thought Wall Street couldn’t sink any lower – when its myriad abuses of public trust have already spread a miasma of cynicism over the entire economic system, giving birth to Tea Partiers and Occupiers and all manner of conspiracy theories; when its excesses have already wrought havoc with the lives of millions of Americans, causing taxpayers to shell out billions (of which only a portion has been repaid) even as its top executives are back to making more money than ever; when its vast political power (via campaign contributions) has already eviscerated much of the Dodd-Frank law that was supposed to rein it in, including the so-called “Volker” Rule that was sold as a milder version of the old Glass-Steagall Act that used to separate investment from commercial banking – yes, just when you thought the Street had hit bottom, an even deeper level of public-be-damned greed and corruption is revealed.

Sit down and hold on to your chair.

What’s the most basic service banks provide? Borrow money and lend it out. You put your savings in a bank to hold in trust, and the bank agrees to pay you interest on it. Or you borrow money from the bank and you agree to pay the bank interest.

How is this interest rate determined? We trust that the banking system is setting today’s rate based on its best guess about the future worth of the money. And we assume that guess is based, in turn, on the cumulative market predictions of countless lenders and borrowers all over the world about the future supply and demand for the dough.

But suppose our assumption is wrong. Suppose the bankers are manipulating the interest rate so they can place bets with the money you lend or repay them – bets that will pay off big for them because they have inside information on what the market is really predicting, which they’re not sharing with you.

That would be a mammoth violation of public trust. And it would amount to a rip-off of almost cosmic proportion – trillions of dollars that you and I and other average people would otherwise have received or saved on our lending and borrowing that have been going instead to the bankers. It would make the other abuses of trust we’ve witnessed look like child’s play by comparison.

Sad to say, there’s reason to believe this has been going on, or something very much like it. This is what the emerging scandal over “Libor” (short for “London interbank offered rate”) is all about.

Libor is the benchmark for trillions of dollars of loans worldwide – mortgage loans, small-business loans, personal loans. It’s compiled by averaging the rates at which the major banks say they borrow.

So far, the scandal has been limited to Barclay’s, a big London-based bank that just paid $453 million to U.S. and British bank regulators, whose top executives have been forced to resign, and whose traders’ emails give a chilling picture of how easily they got their colleagues to rig interest rates in order to make big bucks. (Robert Diamond, Jr., the former Barclay CEO who was forced to resign, said the emails made him “physically ill” – perhaps because they so patently reveal the corruption.)

But Wall Street has almost surely been involved in the same practice, including the usual suspects — JPMorgan Chase, Citigroup, and Bank of America – because every major bank participates in setting the Libor rate, and Barclay’s couldn’t have rigged it without their witting involvement.

In fact, Barclay’s defense has been that every major bank was fixing Libor in the same way, and for the same reason. And Barclays is “cooperating” (i.e., giving damning evidence about other big banks) with the Justice Department and other regulators in order to avoid steeper penalties or criminal prosecutions, so the fireworks have just begun.

There are really two different Libor scandals. One has to do with a period just before the financial crisis, around 2007, when Barclays and other banks submitted fake Libor rates lower than the banks’ actual borrowing costs in order to disguise how much trouble they were in. This was bad enough. Had the world known then, action might have been taken earlier to diminish the impact of the near financial meltdown of 2008.

But the other scandal is even worse. It involves a more general practice, starting around 2005 and continuing until – who knows? it might still be going on — to rig the Libor in whatever way necessary to assure the banks’ bets on derivatives would be profitable.

This is insider trading on a gigantic scale. It makes the bankers winners and the rest of us – whose money they’ve used for to make their bets – losers and chumps.

What to do about it, other than hope the Justice Department and other regulators impose stiff fines and even criminal penalties, and hold executives responsible?

When it comes to Wall Street and the financial sector in general, most of us suffer outrage fatigue combined with an overwhelming cynicism that nothing will ever be done to stop these abuses because the Street is too powerful. But that fatigue and cynicism are self-fulfilling; nothing will be done if we succumb to them.

The alternative is to be unflagging and unflinching in our demand that Glass-Steagall be reinstituted and the biggest banks be broken up. The question is whether the unfolding Libor scandal will provide enough ammunition and energy to finally get the job done.

This post originally appeared at Robert Reich’s Blog and is posted with permission.

7 Responses to "The Wall Street Scandal of all Scandals"

  1. Mike   July 9, 2012 at 7:20 pm

    This is the plan; use it to give the debt forgiveness so many people around the world who need forgiveness- Hell, it is probably" the plan" hatched a couple of years ago! Now there is another conspiracy theory ,but I ask, How can you avoid them, in times like these?

  2. barf   July 9, 2012 at 7:24 pm

    somebody knew. that's why it was called "the Big Short."

  3. Amtak   July 9, 2012 at 10:16 pm

    To Mike: As in Hamlet: "First, kill all the bankers". Or was it lawyers? Whatever.

  4. AndrewMGarland   July 10, 2012 at 12:07 am

    The Libor Scandal
    Some details for understanding what happened. See also Comment 4 by Ken O
    === ===
    [emphasis added]  At best, the scandal has revealed an appalling lack of bank regulation. At worst it suggests collusion at the highest levels between commercial banks, central bankers, and governments to manipulate interest rates for mutual benefit. It’s been suggested that the U.S. Federal Reserve could be dragged into the scandal.

    Ken O: This “scandal” has of course to do with banks. But the borrowers who made out because of it were our own friendly governments. Everyone with a savings account got cheated out of interest payments because governments were and are keeping the rate at which governments can borrow money artificially low. That’s the scandal, and it’s why this will be quickly buried.
    === ===

    Barclays chief threatens disclosure
    === ===
    [edited]  Mr Diamond and the bank have been blamed for “lowballing” the rates at which Barclays said it could borrow from rivals at the height of the 2007-08 financial crisis. Bankers insist the authorities knew these rates were inaccurate but did not object at the time because of fears it could further destabilise panicked markets.
      A senior banker commented that “Regulators knew those rates were not the ones where banks were prepared to lend to each other. They had all the evidence.”
    === ===

    LiborGate
    Guido Fawk's Blog
    === ===
    [edited]  The politicisation and manipulation of interest rates is ongoing. The £275 billion Quantitative Easing (QE) programme implemented by Mervyn King with George Osborne’s blessing is designed to artificially lower interest rates. We currently have a false market in Gilts, it is arguably the biggest bubble since the South Sea Bubble. It is cheating pensioners and savers of income on an unprecedented scale. This is a robbery organised from within the Bank of England
    === ===

    Bloomberg reports that the Libor interbank rate may have been quoted at 10 to 30 basis points lower than in actual transactions, off of a real rate around 2.82%. A basis point is 1/100th of a percentage point.

    Compare this scandal of 30 basis points to the current non-scandal, that US, British, and other government influenced central banks have dictated and manipulated a ZIRP, Zero Interest Rate Policy, which may be distorting interest rates by 300 basis points (who knows?). People who have saved for retirement are being denied interest income because governments are manipulating interest rates downward.

    There is a massive misallocation of resources because the market interest rate has been manipulated. No one can judge the true effects of national policy or the true availability of capital as determined by thousands of market participants.

  5. desi erasmus   July 10, 2012 at 4:21 am

    "No one can judge the true effects of national policy or the true availability of capital as determined by thousands of market participants. "

    In effect the government-bank collusion has turned off the lights on "cost of funds". No wonder interest rate modeling has been such a hair-pulling exercise. Compared to the rapacity of the central banks ZIRP and their government enablers, the amounts lost to the thievery implicit in the Libor scandal is chump change.