Doing the Libor twist: The vice and virtue of interest rate manipulation: Kohler
Wednesday, July 4, 2012/
The Reserve Bank of Australia decided yesterday not to manipulate the overnight cash interest rate. Last month, though, it did engage in price-fixing.
In London, the head of Barclays Bank, Bob Diamond, has been forced to resign because his bank has been manipulating another interest rate, Libor. In fact the Libor-fixing scandal has shaken the whole of banking to its core, again.
Is there a difference between these two things? Of course: central banks are government bodies that manipulate interest rates for the purest of motives, don’t they? They control inflation and maintain full employment by artificially fixing prices in the cash market, which is supposed to send a signal to the banks to adjust their lending and deposit rates. We don’t mind that, because… well, we’ve just gotten used to it.
The banks then go off and fix another rate for their loans, which may or may not be done strictly in accordance with the officially fixed cash rate.
As we know only too well, the home mortgage and small business rate is set according to the various banks’ cost of funds, which is not transparent, so heaven knows what they’re up to.
In the US, housing and business rates are set by the long-term bond rate, not the officially manipulated cash rate, so the Federal Reserve has to do a second manipulation – what it calls “Operation Twist”. That’s where it operates in the bond market, selling short and buying long to get the long rate down, since fixing the cash rate is relatively futile.
The big business rate around the world is set to Libor, which stands for the London Interbank Offered Rate. In Australia it’s the Bank Bill Swap Rate.
Libor is calculated at 11am each day by Thomson Reuters on behalf of the British Bankers Association. Groups of banks on 10 currency panels are asked: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11am?” I kid you not.
Thomson Reuters then takes off the highest and lowest and averages the rest. Bingo – Libor. In Australia the BBSW is the rate at which the banks are actually lending that morning, with a calculation done at 10.08am; with Libor it’s what the banks SAY they are lending at.
I know you’ll find this hard to believe, but it seems that some banks have been fibbing. The Wall Street Journal published an investigation into this in 2008, and then in February this year – only four years later, it had a few things going on, you’ll understand I’m sure – the Securities and Exchange Commission launched an investigation into Libor-rigging.
Barclays Bank chief executive Bob Diamond has now been marched out and placed in the stocks. Overpaid bankers in general are once again in the firing line. Confidence in Libor is in tatters and the BBA is scrambling to restore it before bank customers try something, and someone, else.
Oh, that’s right – they can’t. Banking is a licensed cartel operated by rich executives, where prices are fixed twice: first through market manipulation by government-owned banks and then again by the privately owned banks themselves.
Are we surprised that a bit of corruption sometimes sneaks into a system that is manipulated from top to bottom, rather than set by market forces alone?
Central banks are subject to political pressure and in some cases pressure from their mates among the banks; and second, the banks themselves have been manipulating Libor to improve their profits.
Here I can’t help inserting a little national pride, because neither of our interest rate setting mechanisms has been corrupted, yet.
The Reserve Bank of Australia has been a beacon of independence over the years – and in particular when Alan Greenspan’s Fed was holding interest rates too low for 25 years to keep both Washington and Wall Street happy, the RBA kept them high. That is the reason Australia ended up having a relatively good GFC.
And the BBSW, on which institutional rates are set here, is not what the banks say they are going to lend at each day, but what they are actually doing. So they can’t lie about it.
So anyway, Libor is a mess. But like the credit ratings business that was entirely discredited in 2008, they will have an inquiry, chop off some heads and then promise faithfully never to do it again, cross my heart and hope to be poor, and then get on with life again.
As for the other interest rate manipulation, the one that central banks solemnly do once a month, nobody is questioning whether that is a good idea.
Let me give it a try.
Since central banks started running the monetary system in the 20th century there has been a succession of financial disasters – depressions, inflation, hyper-inflation, and lately the biggest credit bubble and bust in the history of the world. It hasn’t gone well, you’d have to admit.
Why is this? Because central banks come under intense pressure from their owners to keep interest rates low. We see it in Australia, where government politicians constantly play to the mortgage belt by hoping that rates are not raised.
Imagine if it was another basic price that was being manipulated by a government agency to raise and lower aggregate demand – say, rent. There would be constant baying for rents to be lowered; the “rent policy agency” would be in fear of their jobs every time they raised them.
The capitalist system works through investment creating production and productivity. Investment is created by deferred consumption, otherwise known as saving. The financial system exists to collect the savings and direct them to the most productive purpose.
Interest is what borrowers pay to persuade other people to defer their consumption, in the belief that they will be able to consume more later on. The natural interest rate changes all the time according to society’s propensity to save or consume – it’s the rate, taking account of risk, which balances the desire to consume with the desire to save.
If interest rates are artificially manipulated, as they have been by central banks for a hundred years, imbalances inevitably occur because the market clearing mechanism is not allowed to work. The recessions will be deeper and longer and the booms will become bubbles.
It would be fine if all central banks were perfect, like the Reserve Bank of Australia, but unfortunately they are not. After all, they are managed by human beings.
This article first appeared on Business Spectator.
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