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Analysis by Firestorm Expert Council Member Jerry Hudspeth
LIBOR SCANDAL: Risks and Repercussions
The Libor manipulation scandal has dominated the recent news with stories of a culture of corporate greed and bankers who don't know right from wrong. Barclays Bank has been fined $453 million in settlements and politicians continue to be outraged at yet another corporate banking scandal. Because of the Libor's influence in loan industries and markets around the world, however, repercussions go far beyond the halls of investment banks. The LIBOR rate affects trillions of dollars of contracts around the world including mortgages, bonds and consumer loans.
What is Libor?
The London Interbank Offered Rate (Libor) is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks. It is the primary benchmark, along with the four short term interest rates around the world. Libor rates are calculated for ten different currencies and 15 borrowing periods ranging from overnight to one year and are published daily at 11:30 am (London time) by Thomson Reuters. Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it. At least $350 trillion in financial products are tied to Libor.
Risks and Repercussions
There is industry speculation that one result of the Libor manipulation scandal will be a number of lawsuits filed against banks for miss-selling products which were tied to rate, such as derivative contracts and interests rates for swaps. An additional affect could be the increase of Directors and Officers (D&O) insurance claims. If share prices fall, shareholder claims could be filed against corporate officers and directors for failing to do their duty to provide appropriate corporate governance and risk constraints.
Treasury Secretary Timothy Geithner told the Senate Banking Committee that he alerted the U.S. and British regulators in 2008 when he learned of problems with the London Interbank offered rate, or Libor. He was then president of the Federal Reserve Bank of New York. Asked why, four years later, the government hasn’t determined which big banks manipulated Libor. “You have to do them very carefully” Geithner said of the investigations. “Investigations are complex and take a long time”
Libor currently plays such a significant role in shaping the terms of U. S. and global commerce that it is more than a benchmark. It is essentially a gauge for the health of our global financial system. People who manage money use Libor as a gauge of confidence in our financial system.
When Libor is low, this is taken as a sign that money is freely available, without concern that borrowers will fail to pay back their loans. When Libor is rising, this is seen as an indication that concerns are mounting, there is a reluctance to lend money and lenders are proceeding with caution.
Executives of publicly traded banks get rewarded for making their share prices climb, and that tends to happen when they lend more money, make more trades, and take more risks. They get paid for saying 'yes' to deals, not for saying 'no'.
A properly managed Libor is essential to creating and maintaining a solid global financial structure. I would suggest that the U.S. Government regulation and oversight in this area is slow and anemic and many of the banks have less than adequate internal controls.
Unfortunately, I see no quick fix in the future.
Jerry Hudspeth is a highly successful senior executive with over 25 years of experience in the Financial Services industry. Mr. Hudspeth has served as President and CEO for a number of public and private multinational corporations including Portfolio Financial, a Bank of America owned company with over $18 billion under management. >>> Read more
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