LIBOR Manipulation – It only takes one bad apple.

Although we are still a couple of months before 2012 is part of history and there is still a chance that a bigger financial story will appear, I think I will always remember 2012 as the year where widespread manipulation of a main interest rate used by business was uncovered.

Having worked as a commercial bank lender for more than fifteen years, I am sensitive to the mistaken perception that bankers are nothing more than greedy individuals that will sell out their mother for a few basis points. The truth is that there are many different types of bankers, and most of those that hit the news with stories of bad behavior are investment bankers.

Commercial bankers do a lot of good for small businesses. My current employer does dozens of small business loans and a handful of medium sized business loans every month. We provide the financing lifeblood to businesses that employ thousands of people in our community. We bring a lot of value to the table, and even in this still recuperating economy we are putting in close to a billion in new loans per year in our books.

This is why it was kind of shocking to hear about the manipulation of LIBOR. It is even more concerning when people dismiss it because so far only one bank has been caught and penalized. In an internet forum I frequent, a well-respected poster claimed the following:

“Libor is difficult to “manipulate”.  I’ve read quite a few articles on this, and NONE of them contain evidence of the collusion required to actually manipulate the rate.  I’m left wondering whether this is one of those trumped up charges reflecting regulators-gone-wild, or whether there really was collusion, but no reporters ever talk about it, or what.

The mechanism for computing Libor involves THROWING AWAY outliers.  If you’re one of the banks, and you report a high number, it just gets thrown away.  Only if at least 5 banks collude to report a high number on a given day can they actually influence the outcome.  Where is the evidence that this occurred?”

I think this is the wrong way to look at this problem. Even if at the end of the day only Barclays is found to have committed manipulation by submitting false data, one bank can indeed move the final rate by bumping one of the rates from the data set used to calculate the composite. This is best explained by the following graph, which shows that just one bad apple ruins the whole barrel.

impact of one bank manipulating the LIBOR rate

impact of one bank manipulating the LIBOR rate

I think there will be more fallout from this matter and that it is very possible that other banks will be mentioned. If anything is certain, it will be that politicians will use this as something to score points, and demand reform. While my instinct is not to welcome additional regulation when something as basic as the rate that is involved in $350 Trillion worth of financial instruments is violated one has to wonder if regulation is not only a good idea, but something that might be a pressing need.

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