LIBOR's Goldilocks Lies

Includes: ICE
by: Kurt Dew


The bank regulators’ sub rosa involvement with LIBOR has required regulatory lies.

The lies come in three sizes: “too big,” “too small,” and “just right.”.

The “too big” lie: Bank of England’s denial of responsibility for oversight of LIBOR from the beginning, 30 years ago, with Fed support.

We sit and are fed all these lies. Something's got to give.

-- My Only Virtue

The first article in this series summarizes the evolving LIBOR scandal. This second article focuses on bank regulators' use of LIBOR to meet their goals sub rosa.

Bank of England's public involvement with LIBOR began in the 1980's when the Bank of England (BofE) gave its blessing to a new group, the British Bankers Association (BBA), formed to formalize the daily values of LIBOR, which until then were the results of discussions at gentlemen's clubs in The City.

The BofE was LIBOR-involved before that. Undoubtedly from the first utterance of the acronym LIBOR. Experienced London bankers don't fart without asking the BofE for permission.

The newly created BBA designed a method of reporting LIBOR that guaranteed a reported rate above the actual cost of deposits to London banks - by imitating the existing London gold fixing. How LIBOR manipulates deposit rates to enrich the dealer banks is explained here. The gold fixing and how it meets the objective of reporting a financial market value that enriches gold dealers is explained here. LIBOR serves multiple sub rosa functions, both for the banks and their regulators. This article focuses on how regulators manipulate LIBOR to serve their purposes.

LIBOR exists to perpetuate lies of varying magnitude. Classify these lies on a Goldilocks scale: "too big," "too small," "just right."

The "too big" LIBOR lie: Before the Crisis, LIBOR was totally unregulated.

LIBOR exists to provide for settlement purposes a daily public interest rate - the LIBOR fixing: LIBOR, according to the meaning the acronym (London Inter-Bank Offered Rate) is a measure of the cost of wholesale deposits to the most creditworthy global banks. But, by design, the official LIBOR fixing exceeds the cost to big banks of funding themselves. In other words, LIBOR was constructed with the objective of manipulation of the public version of dealer bank borrowing costs in dollar terms.

LIBOR exists to overstate bank costs of money. This lie exists it produces profits to the banking system of enormous, unmeasurable value. An above-the-market LIBOR is worth many billions to the commercial banks every year. I explain the details of the mechanism by which the LIBOR lie is released daily, and why it is a lie, here.

The value of this LIBOR lie is so enormous that financial institutions and their regulators will move mountains to deny the simple fact that LIBOR is too high. With each new LIBOR scandal, the way LIBOR is calculated changes. LIBOR becomes ever-more transactions based and continuously more electronic. Baloney. What will never change without direct public pressure is the fact that LIBOR is set too high. Indeed, regulators are unwilling to admit that they had a role in its creation, or that they could rid us of it. The leave the changes to the exchange management firm favored by the dealer banks, Intercontinental Exchange (NYSE:ICE). Preserving this myth of regulatory hands-off, an "emperor's new clothes" kind of lie. This lie is so big, it cannot be spoken.

This "too big" lie, that the manipulative purpose of LIBOR is a surprise to regulators, is the most important, least publicized, aspect of the current scandal. LIBOR fits squarely in the BofE-backed tradition of London price fixing - which began over a century ago with the London daily gold fixing. Financial price fixing is a process that has been condoned and guided by the BofE from its beginning. Today, in addition to gold and LIBOR, there are foreign exchange fixings, and several derivatives fixings. All developed under the watchful eye of the BofE.

The key to understanding British regulation is that it is regulation by implicit carrots and sticks, not by written rule. Policy is promulgated in meetings governed by Chatham House Rules. Or was, until the Crisis began to squeeze the BofE. If the big banks cooperate with the BofE, these banks may maintain their oligopoly profit-driven OTC market price fixings. If banks are relatively well-behaved, the BofE avoids scandals of its own by professing that there are no regulations governing the dealer banks. How could BofE possibly be held responsible for a multi-billion-dollar annual price manipulation? They are not in charge.

BofE regulates by leverage, in other words. The banks may keep their LIBOR fiction and its profits if they cooperate. BofE, in return, escapes culpability for its actions since it has established no regulations. And as part of the bargain, the American banks pay a substantial share of British tax revenues.

The lie that's "too small." The bank regulators pressured the banks to reduce LIBOR during the Crisis.

I find this most recent BBC discovery profoundly uninteresting - and thus "too small." Any informed follower of events during the Crisis knew then that the high levels of bank wholesale deposit rates, symbolized by LIBOR, were a serious policy concern to both the Fed and the BofE, and that both had opined publicly that LIBOR was "unrepresentative" of business conditions. No close follower of the modus operandi of regulatory interaction with the big dealer banks could doubt that this expression of regulatory concern was sufficient to bring LIBOR down. There was no need for direct conversations between regulators and senior commercial bankers about LIBOR. There was a bona fide policy reason to reduce LIBOR. Both the Fed and the BofE wanted it done. The fact that BofE ultimately needed to place a call to Barclays to get that bank to fall in line is just Barclays, being either stubborn or stupid.

That regulators on both sides of the Atlantic might not have pressured the dealer banks to bring LIBOR to lower levels is beyond my imagination. It was the right economic policy. And the cost to the banks in terms of profits has long ago been paid for multiple times by regulators' "too big" lie - the decision to look away from the manipulative LIBOR fixings.

The "just right" lie. A new list of scapegoats. Which must include the scandal's gatekeepers.

There is a new lie coming. With each new "LIBOR scandal," the world demands a new set of scapegoats. Here is a list of the new media-chosen scapegoats. The BBC article focuses on two phone calls. The first, a communication between an official at the BofE, Paul Tucker, and Barclays CEO Bob Diamond; the second, a conversation between Mark Dearlove, a senior manager at Barclays; and Peter Johnson, Barclays' LIBOR submitter.

The former call from BofE to Barclays pressures Barclays to reduce their LIBOR submission. The second call, to Johnson, makes it clear that in Barclay senior management's mind, BofE was demanding a change in its previous policy of "requesting" that the banks submit their best judgment of the rate at which the bank could raise wholesale money. BofE now wanted the banks to provide LIBOR submissions at a lower level. This creates a new scapegoat: Mr. Tucker. Unfortunate for Mr. Tucker since his phone call is really only symbolic of hundreds of communications between BofE and the dealer banks needed to implement BofE's unwritten regulation of LIBOR. Not to mention scores of calls from Washington regulators to the BofE to make sure BofE did not wander off the regulatory reservation.

The reason the lie is of "just right" importance is this. Those communications are evidence, and not simply evidence of the "too small" lie. They are evidence of the custom of regulation through sub rosa contact.

The fact that we are learning of them now means the communications are evidence withheld. Itself a crime. And the evidence reveals both that BofE wanted a change in LIBOR and that this wish carries all the weight of a regulation. But that regulation, BofE reminds us, does not exist. The result of the phone calls, a lower LIBOR rate, shows that a regulation did not need to exist for BofE to be culpable for a lower, manipulated, LIBOR.

And the BofE response to this scandal shows just how clever BofE believes its "What regulations?" policy was. A BofE spokesman asserted in response to the BBC news that the regulator could not possibly be blamed for this naked example of LIBOR manipulation.

The market was not regulated by the Bank of England or anyone else at the time of the phone calls,"

the spokesman explained.

It is time for the courts to go after the BofE and, beyond doubt, the Fed as well, if evidence of Fed involvement can also be "discovered."

There is another scapegoat. Who sat on this communication between the BofE and Barclays until now, other than the participants themselves? Is the withholding of knowledge of this communication not, at the very least, obstruction of justice? That communication would have been significant evidence in the trial of Barclays LIBOR submitter, Peter Johnson, who went to jail for providing manipulated values of LIBOR. But Johnson's submission was made, we now know, as a result of an order from a superior based on a request from the BofE itself. Would the LIBOR provider, Johnson, have been convicted if that evidence had been available? No. Responsibility, as we knew in 2008, rests far higher in the chain of authority than the lowly LIBOR providers. Now there is proof.


LIBOR is simply an important signpost in the long road of British market manipulation of financial market prices through "fixings." From the creation of the first London fixing, the London gold fixing, enrichment of the market's dealers at their customer's expense was a central part of the design of a London financial markets. Something BofE has fully understood and condoned for over a century. The premium of gold dealer's inventories valuation to their customers' is part of the rules by which the London Bullion Market Association fixes gold prices. The premium built into LIBOR is not explicit, but it is easily understood.

It is tempting to place the blame for the OTC markets and their many implicit manipulations upon the big dealer banks. That is what the courts have done to date. And the dealer banks deserve much of the blame. But not all of the blame. After the BofE revelation, legal responsibility is moving up the banking hierarchy. Is there really any doubt that the ultimate responsibility for LIBOR and its flaws has always rested at the very top of the American/British pyramid of authority?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.