Paul Jorion worked from 1998 to 2007 in the American banking sphere as a pricing specialist. Here he sets out his vision of ‘Liborgate’ which is currently shaking British banks.
Le Point.fr : What is the LIBOR rate and what is it used for?
Paul Jorion : It’s the rate at which the banks lend to each other. Each establishment declares the rates its competitors charge it in order to lend for three months, six months, a year. Other loan rates are then defined in relation to this rate (consumption, housing), particularly variable rates.
How did the British banks manipulate the LIBOR?
During the period from 2004 to 2007, the banks artificially revised their declarations, either upwards or downwards. But they only manipulated them by modest amounts, roughly one to one and a half basis points, or a hundredth of one per cent. As only one bank was cheating from the panel of 16 which is used to establish the LIBOR, the impact would have been extremely limited, unless they acted in a concerted manner, of course.
In that case, why did the banks try to manipulate the LIBOR?
During the period I just mentioned, from 2004 to 2007, it was a result of individual initiatives from traders in the banks. They would call up a friend in the service who was responsible for declaring the rates, and ask for a small reduction or increase, in order to help their market positions.
During a second period from 2007 to 2009, the mechanism was completely different. Politicians called the directors of the central bank, the Bank of England, to tell them to massively lower the LIBOR rate and save the financial system. These latter then called in turn the executive managers of the banks to get them to lower the rates. But this time, the reduction was by as much as 20 or 30 basis points, which was 20 or 30 times more than the manipulations in the preceding period! This can be explained by the fact that the rate a bank is charged is a sensitive piece of information: it includes a risk premium – the most substantial part of the rate in times of crisis –, which reflects the degree of confidence that other banks have in its capacity to reimburse the loan and make interest payments. The greater the risk of non-repayment, the higher the rate that is charged.
So the LIBOR scandal helped to prevent the global financial system from collapsing?
Absolutely. When a banker like the chief operations officer Jerry del Missier was asked why no alarm bells rang when he was ordered to manipulate the rates, he replied that it was a reasonable decision to take, since it was a means of saving the system….
Why is this affair causing such indignation at the moment?
First of all, it should be noted that this scandal dates back to some time ago. The reason why it has provoked such a scandal now is due to the climate of public opinion. Three or four weeks ago, the public learnt that the first bank to be convicted, Barclays’, had been required to pay a fine of 365 million Euros (it is not that the others are innocent, but that one bank at a time is being examined). This announcement was made in a context where the public was already incensed with the ruling class. It overreacted. Moreover, the governor of the central Bank of England and the president of the Financial Services Authority admitted that they had been astounded by the strength of the backlash. The public had learnt the previous July that Rupert Murdoch had managed to build up an extraordinary influence over affairs and had hacked into 4000 mobile phones! Furthermore, not a day passes without an adverse story about financial establishments, like the HSBC money-laundering scandal which has just come to light. The indignation, one could almost say disgust, has reached such a level that news which might previously have been found on page 17, now finds itself on the front page.
Why were the banks not afraid of being punished?
Firstly because of the trend towards deregulation, and then the abrogation in the United States of the Glass-Steagall Act (a law which separated commercial banks from deposit banks, editor’s note) in 1999. Subsequent American Administrations have been extremely favourable to big business and funds for regulators have been cut. There has also been a decriminalization of financial crimes. This was one of Sarkozy’s major projects, in particular.
Is the separation of commercial banks from banks which hold savers’ deposits a solution?
I believe that the solution is not just to separate the speculative activity of banks and their classic role as intermediary. Speculation should purely and simply be banned. Preventing banks from using their savers’ deposits on the markets would merely put a brake on their speculative activities; they would borrow the money from elsewhere. One should not allow some banks to specialize in speculation as it makes no economic sense. Speculation plays no useful role in an economy. It was forbidden in France until 1885. Three articles forbidding speculation exist in the Penal Code and Civil Code. They should simply be reinstated.
* Le Point is a French weekly news magazine.
Translated from the French by Tim Gupwell