Proposals for reform of the Libor system, which determines the interest rates in financial transactions worth trillions of dollars, will do little to stop manipulation that lies at the very heart of the global financial system.
The reform measures, announced two weeks back were drawn up by Martin Wheatley, managing director of Britain’s Financial Services Authority (FSA), after it was revealed that global banks had been manipulating the system in order to rake in billions of dollars and protect their own positions. The much-vaunted ‘free market’ was revealed to be a shell game run by bank executives, big investors and financial traders.
Libor, the London Interbank Offered Rate, is an interest rate set every day based on reports from major international banks. The banks estimate how much they would be charged for short-term loans from other major banks. The average of these estimates then becomes the basis for interest rates throughout the global financial system. It is calculated that financial products worth around $800 trillion are linked either directly or indirectly to Libor.
The manipulation at the heart of the system came to the surface last June when the British bank, Barclays, admitted to wrongdoing insubmitting its Libor rate.
It was subsequently revealed that Barclays was only one of about 20 banks under investigation for trying to manipulate the Libor rate to their own advantage.
The proposals for what Wheatley called ‘a complete overhaul’ of the Libor system involve a cutback in the number of rates on offer, the appointment of an administrator, and tighter regulatory oversight. The British Bankers’ Association, which has operated Libor, hasannounced that it will now withdraw.
While the changes will make it more difficult to rig the system, Wheatley’s overriding concern was not the removal of the ‘criminality’ that had been so dramatically revealed last June, but to give the appearance of initiating tough measures in order to assuage public outrage.
The Libor system, he said, needed to “get back to doing what it is supposed to do, rather than what unscrupulous traders and individuals in banks wanted it to do.”
Speaking on the BBC’s ‘Today’ programme, Wheatley indicated that bankers found guilty of manipulating Libor could be jailed in the future. “Society has lost confidence in banks, in finance, in the whole system, and we need to restore that. Society wants the people who commit these sorts of crimes to pay the price and if that includes jail for the most extreme fraud in the system, then that’s what should happen.”
The obvious question is why is it not happening now? The answer is contained in the nature of the Wheatley inquiry itself.
The terms of the review stated that it would “not consider any issues relating to the actions or alleged actions of specific financial institutions” in attempting to manipulate Libor or other benchmark rates. The investigation of these matters would be left to the FSA and other regulatory bodies around the world.
The attitude of these bodies has already been made clear. Despite Barclays’ open admission that it had broken the law, the US Justice Department granted the bank immunity from criminal prosecution and did not name any executives or traders in exchange for the financial settlement. Given that the $450 million fine was a slap on the wrist in comparison with its annual revenue of $50 billion, Barclays was more than happy to pay up.
Despite the tighter regulations, the essential foundations of the Libor system will remain intact. Wheatley said given the extent of the contracts for which the Libor rate provides the foundation, it was not possible to scrap it entirely. In other words, all the avenues for manipulation remain open.
This is because the banks will still be involved in setting the interest rates that determine the profits they make from transactions in global financial markets based on those same rates.
The sums involved are enormous. For example, on a $50bn portfolio of derivatives contracts, a bank stands to gain or lose $1.25 million on each movement of just one basis point (a basis point is one one-hundredth of one per cent). Multiply that several times and then, as the saying goes, a billion here and a billion there and fairly soon you are talking about big money.
It will now be somewhat more difficult to organise such manipulations, but as one trader commented to Reuters, the reforms ‘may just create a better thief.’—Courtesy: WSWS