Sunday, July 22, 2012

Flaws, Frauds and the $300 Trillion LIBOR Crisis

As the probe expand globally, after senior executives at Barclays Bank resign and the firm pays multi-million dollar settlement fees for LIBOR manipulation, consider the following commentaries: The Economist – it is “the rotten heart of finance”, Barney Frank – “this is fundamental dishonesty” and “this notion of self-regulation is a mistake”,   Eliot Spitzer  - “this is about as big as it gets in the financial world and goes to the heart of every piece of debt that’s issued to consumers”,  MIT finance professor Andrew Lo - "this dwarfs by orders of magnitude any financial scams in the history of markets",  Elizabeth Warren - "the Libor fraud exposes rot at the core of the financial system", the U.S. Treasury’s Office of Financial Research - “this type of manipulation -- poses significant risks to market integrity and investor trust, and will require continuing regulatory focus”,  Federal Reserve Chairman Ben Bernanke - “the Libor system is structurally flawed,” and “it is a major problem for our financial system and for the confidence in the financial system, and we need to address it.”

A brief primer on LIBOR (London Interbank Offered Rate)
  • LIBOR is an index used to set pricing of between $300 and $500 trillion worth of mortgages, student loans, commercial loans and derivative contracts
  • small changes in the index can impact financial markets and borrowers -  a 0.01% change can have a $30 to $50 billion impact,
  • over 75% of U.S .commercial and mortgage loan valuations are dependent on the index,
  • the rate is not set by market demand, but an “honor system” by bankers and traders at 16  major financial firms – many of the usual suspects,
  • manipulating LIBOR can  help traders make more money and improve their firm’s  financial appearance and
  • emails by bankers and traders related to potential LIBOR rigging are emerging such as  “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger”.

While the scale of the LIBOR manipulation problem is amazing (the abuses extent back to at least 2007), the discovery of continuing problems in the global financial system and complacency and lack of oversight by regulators and policy makers is no longer shocking.   Perhaps a factor contributing to the long recovery process from a major financial crisis is that it takes time to remove a generation of “bad actors” from the stage.    

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