Not being in banking or finance, I can't say that I knew until recently. The LIBOR is the London Interbank Offered Rate. Basically, it is a statistical average of the interest rates that banks loan to money to other banks at. It is published daily and utilized by pretty much every banking and financial institution to set their benchmark interest rates.
Before I delve in, I need to make a correction to the statement above. The LIBOR is the average of the interest rates that banks claim they would get were they to borrow money from other banks. That's right, this rate, which underlies nearly all other interest rates, is computed by self-report. It is meant to be computed by staff at each bank independent of staff that manage exchanges.
Self-report is an ideal alternative to regulation, but it does not always work out when that self-report is tied to more than basic data collection. In this case, a self-report system has grown tied to some of the very foundations of modern banking and finance. Reports from a variety of outlets (a few examples are here, here, and here), including some academic work noting that self-reported interest rates were overly similar across different levels of risk at different banks, suggest LIBOR manipulation. More clearly, they suggest that self-reported interest rates were artificially depressed, implying to consumers that the banks were safer bets than the truly were. As the articles note, regulators are investigating.
Apart from all the noise over who manipulated, how they manipulated, who has standing to sue and how much they can get (being from Baltimore, I really doubt that the city will make use of the funds the Economist article suggests it may win), the biggest question should really be: how can the LIBOR be fixed? It does not seem fair to let the banking sector have yet another mulligan. There needs to be a system in place, and a system that operates efficiently enough to continue daily postings of the LIBOR. One option would be to introduce some sort of computational analysis that would combine with the self-report, a la a BCS-style system in NCAA college football; however, if such a system has so little support in football, could it really benefit in finance? Another option would be to develop a regulatory scheme that would compare submitted figures with independent analysis; however, cost and timeliness could be issues. A third option may be to regulate by reviewing submitted data after the fact and adding accountability for accuracy back into reporting. This option is better, but the possibility of backlog and the potential costs may be issues.
It is unclear what the best option really is. It may benefit to explore having banks report the rate they claim they could borrow at alongside the rate they would lend at. Also, since banks lend continuously, it may be helpful to group banks by operations and size and have them cross-report lending and borrowing within their cohort. Regardless, accountability needs to be instilled into LIBOR reporting, as well as a penalty scheme for the organization, not just the individual.
Clearly, no option currently on the table is perfect. However, most of the options are better than financial manipulation. Maybe this financial crisis and its after effects will teach us lessons not only about our economic models and their premises, but also about human decision-making.
No comments:
Post a Comment