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The Barclays Scandal is in Fact Every Bank's Scandal

Posted: 07/05/2012 1:08 pm

Canadians have yet another reason to be wary of bankers: A scandal is brewing across the pond in the United Kingdom that may have serious international effects on consumer confidence in the financial system. The furor has already claimed the CEO of Barclays, the world's fourth largest bank, who resigned in disgrace yesterday. Further resignations at the bank will no doubt continue throughout the week.

The outrage, which promises to grow significantly larger in coming weeks, concerns allegations that Barclays, the Royal Bank of Scotland and other banks were manipulating over $10 trillion dollars in loans by lying about the rate they paid to one another when borrowing money.

Barclays has already admitted to the allegations and has been fined $450 million by British and U.S. regulators. Bankers lying to one another in the United Kingdom may seem unimportant (and surely happens all the time) but this news should be of interest to you because their lies might have affected millions of people living outside the U.K.

The greater scandal here is that other banks were manipulating the London interbank offered rate (LIBOR) to make it appear as though they were lending money to one another at low rates of interest during the financial crisis and immediately afterwards. This would improve their credit scores, provide them with the mirage of better overall financial health and of course, help them make more money.The rate fixing might have went in the other direction too - an attempt to increase the rates if it was favorable to their interests. There are intonations that this manipulation was done with the quiet consent of public officials. There are even intonations that this manipulation was done with the quiet consent of public officials.

The LIBOR matters: It forms the basis of many lending operations around the world. Millions of consumer and business loans have their interest rates pegged to the LIBOR rate and were under the perhaps mistaken impression that the rates were not fixed. The LIBOR has an effect on the real economy. The Wall Street Journal has calculated that that LIBOR affects $800 trillion worth of contracts.

Here is an example, a lender in Canada or the United States might allow a customer to borrow at LIBOR plus five per cent. The LIBOR average is what drives the interest rates for hundreds of millions of people on their mortgages, student loans, insurance products and business loans -- it affects a hugely diverse group of people.

More unnerving than Barclays' manipulation of the rate is the fact they were almost certainly not alone. In order to affect the overall rate, there would have to have been large scale collusion with other banks. This is the equivalent of price fixing between gas companies when you go to the pump each week. Dishonesty is so common in the industry that Barclays claimed they submitted fraudulent estimates of their borrowing costs because they believed their rivals were also being dishonest; if they were honest it would have proven a disadvantage.

Financial regulators are investigating the rate setting practices of nearly 20 banks, including the Royal Bank of Canada. If banks were manipulating the LIBOR, what they were basically doing is taking money out of the public's pocket. It would be the public's mortgage rates that changed, and because their interest rates changed, their loans and credit cards rates or pension incomes would change. If these numbers were being manipulated for the sole purpose of improving the banks profit and balance sheet, the public was most assuredly affected negatively.

This scandal and others, like the Facebook IPO debacle, make it appear as though there are two worlds in the financial sector's solar system. On one of these worlds inhabit the ordinary taxpaying public who are given half-truths, and are removed from the burden of their money at a speed that defies Einstein's theory that nothing moves faster than light. In the other world are the insiders who are largely protected from the risks in the financial system, and play by a completely different set of rules. Both of these worlds cannot continue to exist. A collision is inevitable.

This scandal may be positive in at least one way; when the head of Barclays, Bob Diamond, resigned he set a precedent. If five or 10 of the world's biggest banks are also implicated in the scandal, we could see a significant number of some of the most powerful bankers in the world resign or be replaced in shame. It would be a transformative moment for the industry. It's always darkest right before dawn.

 

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