While the media pays enormous attention to JP Morgan losing $2 billion (or up to $9 billion, apparently), a far more serious scandal has received relatively little attention. The CEO of Barclay’s has admitted to rigging the value of the London InterBank Offered Rate (LIBOR) index. Having spent several years in the mortgage business, let me explain why this matters.
The vast majority of adjustable rate mortgages, including 2/28 subprime mortgages (loans with a fixed rate for two years, then variable after that), use the LIBOR to calculate the interest rate after the fixed period of the loan ends. That means the LIBOR index controls the rate that people pay on their mortgages — if the LIBOR goes up, so does the payment tens of millions of people have to pay on their mortgages. In fact, an estimated $360 trillion worth of property in the world is indexed to the LIBOR value.
Dylan Matthews explains what Barclay’s did:
So how did the manipulations by Barclay’s affect this rate? First, from 2005 and 2007, the bank allegedly varied the rates it reported to the BBA and Thomson Reuters so as to improve its margins on internal trades. For example, it could have placed bets that the LIBOR rate would increase, and then reported artificially high rates which in turn artificially increased the LIBOR averages, so that the bets were likelier to pay off. This not only screwed the investors on the other side of the trade, but bumped up mortgage rates – however infinitesimally – for consumers even when the risk of the loans hadn’t changed at all.
Second, in late 2008 Barclay’s – and, Diamond alleges, other banks – apparently low-balled the rates they reported for LIBOR averaging so as to make the banks’ finances look more stable than they were. The idea was to put out a false image of stability to prevent market panic and stave off calls for additional regulation or even nationalization, a solution that looked increasingly likely during the height of the financial crisis. The direct effect for consumers here was to make loans cheaper, but the indirect effect, or the intended one at least, was to lessen chances of government action against the banks. So the banks manipulating LIBOR weren’t just messing with peoples’ finances – they were trying to mess with the peoples’ laws.
Barclay’s will pay $450 million in fines, which is a drop in the bucket compared to the company’s assets and income. Fines do very little to deter such conduct by major financial companies; it’s simply a cost of doing business. If they can make more by breaking the law than they will have to pay in a fine, they’re going to do it. There needs to be serious penalties for this kind of thing, penalties that include long jail terms for the executives who engage in it.