The Insightful Trader

Archive for July, 2012


by on Jul.06, 2012, under Editorials

So now disgraced former Barclays chairman Bob Diamond claims that, at the behest of unnamed “Whitehall officials,” the Deputy Governor of Bank of England pressured him to go along with a scheme to get the headline Libor rate down below the lending rates banks actually charged. That’s right, the very day Diamond was to testify before Parliament in its Libor investigation, an exculpatory email just happens to surface.

For the moment, though, this email remains unverified. Deputy Governor Paul Tucker denied the story and offered to testify to his side of it.

If we assume Diamond is actually telling the truth (not always the right thing to do), then, I have at least two questions. First, which “Whitehall officials” would dare suggest to the BOE’s number two man, that he pressure bankers to commit what amounts to fraud? The Chancellor of the Exchecquer, or even the Prime Minister? If the email turns out to be genuine, we are talking about very big names rather than junior assistant flunkies.

Secondly, who would even come up with an idea like this? My money is on US Treasury Secretary Tim Geithner. Fed Chairman Ben Bernanke wouldn’t surprise me either.

This is pure speculation on my part, of course; as I say, the email is unverified, and neither of their names has yet come up in evidence. But manipulation of Libor would be very consonant with the Geithner/Bernanke policies of bailing out banks and keeping up confidence in the banking system.

Libor Certainly Matters Enough for Someone to Rig It

As many readers know, Libor (the London Interbank Offered Rate) is set daily by the British Bankers Association, from rate quotes submitted by the Association’s members. Many variable rate loan contracts worldwide, reset periodically based on the Libor rate. That’s why so many people have taken the scandal seriously.

I bring up Geithner for two reasons. First, he has certainly been a strong advocate for bank bailout policies both in the US and abroad. Second, a cornerstone of Geithner’s (and Bernanke’s) bailout policy, has been to make banks look more sound than they really are. In addition, low Libor is consonant with the Fed’s zero interest rate policy (ZIRP).

Manipulated Libor Rates Boost Confidence in Banking System

Bernanke and Geithner have done what they could to boost confidence in the banking system; that is what they were after, for example, when they ran the bank stress tests. They believe that if they can keep confidence up, the system will have time to heal itself. That’s one reason I would not be surprised if either or both of them acted to suppress Libor quotes.

Low quoted Libor rates exaggerate the confidence banks have in each other — they tell us that banks are lending to each other cheaply, rather than worried enough to charge a risk premium. That is a key point since financial contagion – the process by which financial distress spreads from one institution to another — has been policymakers’ number one nightmare since 2007.

Officials are keenly aware that contagion can spread, not only when one institution defaults on payments to another, but when the market begins to fear that might happen. Given that Geithner has opted to paper over the GFC rather than fix its root causes, he has ironically left the system far more exposed to contagion than would otherwise be the case. All the more reason, then, to encourage confidence any way he can.

Previous Attempts to Manipulate Confidence are Public Knowledge

Manipulation of the quoted Libor rate would also seem to be of a piece with the Fed’s manipulated “stress tests” that turned out to be a propaganda exercise proclaiming bank soundness, rather than a regulatory exercise to ferret out and correct bank weakness. And not just because monkeying with Libor is a similar confidence game.

After all, think about how a stress test works. The “tests” asked how banks would perform if the economy were to weaken again. And how do financial institutions fail? A lack of liquidity, the ability to pay bills NOW. In a crisis, when depositors withdraw funds en masse with just a few mouse clicks, liquidity gets squeezed rapidly. Low short term rates are a key indicator of liquidity. By artificially lowering Libor, bankers exaggerate the “liquidity” apparently available in the system. It’s another way for the bankers to say, “No problem, mon.”

Low Libor Rates Could be a Facet of ZIRP

Bernanke’s interest rate policy has been to create actual liquidity available to big institutions with his ZIRP. ZIRP has kept Treasury rates low across the curve. Low quoted Libor rates keep payments down for people who owe money based on Libor rather than on Treasury rates, even if they do not increase actual interbank liquidity.

Low Libor rates could also keep some bankruptcies from taking place during a crisis. So a low Libor rate is something Bernanke could love; it’s of a piece with his zero interest rate policy.

Still, Suspicions about Bernanke and Geithner Remain an Educated Guess Until Proven Otherwise.

Only British Government pressure has been alleged (and not proven) thus far, regarding Libor rates. No evidence of American government pressure has emerged yet. Furthermore, no one has yet proven (or disproven) Diamond’s email.

I’m just saying, that government pressure to lower quoted Libor rates would be extremely consonant with the bank bailouts that are so central to American policy. That’s why I will be watching to see if the e-mail proves turns out to be authentic and if so, how the idea of Libor manipulation originated. And if our doughty US policymakers actually turn out to have had a part in this, well, you heard it here first.

Disclosure: No positions in stocks mentioned.

This post has been updated.


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