In the wake of the financial crisis caused in large part by the reckless behavior of banks, we have wrestled with institutions that are "too big to fail" and "too big to jail."
Now, after evidence of a widespread fraud on a key benchmark interest rate that has cost borrowers and savers billions of dollars, we may be dealing with something "too big to replace."
The rate in question, which is used to adjust interest rates on everything from swaps to mortgages, is the infamous Libor, an acronym which stands for London interbank offered Rate — the rate at which banks in London supposedly make unsecured loans to each other.
It emerged last year that some of the 18 international banks involved in setting Libor each day were manipulating this rate, which means that on each of millions of securities, loans and retirement plans using Libor as a benchmark someone — U.S. cities and school districts, homeowners, retirees — got cheated.
Regulators found e-mails from bank staffers asking friends at competing banks to fudge the rate in return for steering them brokerage business — or a bottle of champagne or, in one case, leftover sushi!
Three banks — British banks Barclays and RBS and Swiss bank UBS — paid a total of $2.5 billion in fines for falsifying Libor rates.
So once this malfeasance was discovered, banks stopped using the compromised rate in their products, right?
Nope. As with so many of the banks' abusive practices, regulators are moving at glacial speed to rectify the situation, and in the meantime this dubious benchmark continues to be used in numerous financial products.
After due deliberation, U.K. authorities announced they will remove oversight of Libor from the British Bankers Association and put it under government regulatory authorities.
But governance is not the only problem with Libor. The fact is that banks have virtually ceased making unsecured loans to each other so that Libor is pretty much a total fiction.
For this reason, Gary Gensler, chairman of the Commodity Futures Trading Commission, the U.S. agency responsible for regulating swaps, suggested in a speech last month in London that it is time to find a benchmark rate that is more honest in spite of Libor's widespread use.
"It's best that we not fall prey to accepting that Libor or any benchmark is 'too big to replace,' " he told an audience of regulators and bankers.
Last month's annual report from the Financial Stability Oversight Council — the interagency body set up in the U.S. in the wake of the financial crisis to identify and defuse potential threats to the global financial system — listed the damaged integrity of Libor as one of the major potential risks it is currently worried about.
Calling attention to the dearth of any actual transactions at this "interbank" rate, the report warns, "This situation leaves the financial system with benchmarks that are prone to and provide significant incentives for misconduct."
Gensler documented the fictitious nature of Libor for his London audience in a series of slides comparing bank credit rates during the recent crisis over a possible exit by Cyprus from the euro.
While other measures of credit for international banks, such as the cost of credit default swaps for these institutions, were swinging widely during this period, the banks' submissions for Libor remained unchanged.
"One might have thought the two would have had some relation to one another," Gensler said.
What Gensler and the FSOC want is a benchmark set by on observable process anchored in a real market. For instance, while many adjustable-rate mortgages in the U.S. are based on Libor, others use much more widely based or verifiable benchmarks, such as the cost of funds index (COFI) from the San Francisco Federal Reserve or the one-year constant maturity Treasury (CMT) based on an average of yields on Treasury securities.
However, not only are the big banks resisting any change, authorities in the U.K. are dragging their feet on scrapping Libor, arguing that improved governance will help and that a change of this scope would be disruptive.
The U.K. wants at all costs to maintain London's role as a hub of global finance. Financial and related professional services employ some 2 million people in the U.K. and account for nearly 15% of the country's GDP, more than in any other industrial country.
So London is showing little sense of urgency even in making the move to better supervision, let alone finding suitable alternatives.
If borrowers and pensioners here are to be protected from further losses due to fraudulent manipulation of this key rate, it will be up to U.S. authorities to keep pressing for alternatives, even if they have to do it alone.
Source: http://www.usatoday.com/story/money/business/2013/05/14/delamaide-column-libor-scandal/2158085/
Now, after evidence of a widespread fraud on a key benchmark interest rate that has cost borrowers and savers billions of dollars, we may be dealing with something "too big to replace."
The rate in question, which is used to adjust interest rates on everything from swaps to mortgages, is the infamous Libor, an acronym which stands for London interbank offered Rate — the rate at which banks in London supposedly make unsecured loans to each other.
It emerged last year that some of the 18 international banks involved in setting Libor each day were manipulating this rate, which means that on each of millions of securities, loans and retirement plans using Libor as a benchmark someone — U.S. cities and school districts, homeowners, retirees — got cheated.
Regulators found e-mails from bank staffers asking friends at competing banks to fudge the rate in return for steering them brokerage business — or a bottle of champagne or, in one case, leftover sushi!
Three banks — British banks Barclays and RBS and Swiss bank UBS — paid a total of $2.5 billion in fines for falsifying Libor rates.
So once this malfeasance was discovered, banks stopped using the compromised rate in their products, right?
Nope. As with so many of the banks' abusive practices, regulators are moving at glacial speed to rectify the situation, and in the meantime this dubious benchmark continues to be used in numerous financial products.
After due deliberation, U.K. authorities announced they will remove oversight of Libor from the British Bankers Association and put it under government regulatory authorities.
But governance is not the only problem with Libor. The fact is that banks have virtually ceased making unsecured loans to each other so that Libor is pretty much a total fiction.
For this reason, Gary Gensler, chairman of the Commodity Futures Trading Commission, the U.S. agency responsible for regulating swaps, suggested in a speech last month in London that it is time to find a benchmark rate that is more honest in spite of Libor's widespread use.
"It's best that we not fall prey to accepting that Libor or any benchmark is 'too big to replace,' " he told an audience of regulators and bankers.
Last month's annual report from the Financial Stability Oversight Council — the interagency body set up in the U.S. in the wake of the financial crisis to identify and defuse potential threats to the global financial system — listed the damaged integrity of Libor as one of the major potential risks it is currently worried about.
Calling attention to the dearth of any actual transactions at this "interbank" rate, the report warns, "This situation leaves the financial system with benchmarks that are prone to and provide significant incentives for misconduct."
Gensler documented the fictitious nature of Libor for his London audience in a series of slides comparing bank credit rates during the recent crisis over a possible exit by Cyprus from the euro.
While other measures of credit for international banks, such as the cost of credit default swaps for these institutions, were swinging widely during this period, the banks' submissions for Libor remained unchanged.
"One might have thought the two would have had some relation to one another," Gensler said.
What Gensler and the FSOC want is a benchmark set by on observable process anchored in a real market. For instance, while many adjustable-rate mortgages in the U.S. are based on Libor, others use much more widely based or verifiable benchmarks, such as the cost of funds index (COFI) from the San Francisco Federal Reserve or the one-year constant maturity Treasury (CMT) based on an average of yields on Treasury securities.
However, not only are the big banks resisting any change, authorities in the U.K. are dragging their feet on scrapping Libor, arguing that improved governance will help and that a change of this scope would be disruptive.
The U.K. wants at all costs to maintain London's role as a hub of global finance. Financial and related professional services employ some 2 million people in the U.K. and account for nearly 15% of the country's GDP, more than in any other industrial country.
So London is showing little sense of urgency even in making the move to better supervision, let alone finding suitable alternatives.
If borrowers and pensioners here are to be protected from further losses due to fraudulent manipulation of this key rate, it will be up to U.S. authorities to keep pressing for alternatives, even if they have to do it alone.
Source: http://www.usatoday.com/story/money/business/2013/05/14/delamaide-column-libor-scandal/2158085/
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