6 Ways Big Banks Screwed Grandma in the Price-Fixing Scandal That's Rocking the World
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Every business day at 11am, London time, something critical to the world economy happens. Leading "reference banks" are asked what they believe borrowing rates to be. Based on what they say, LIBOR (London Interbank Offered Rate) is set for that day. Those rates then flow through to the broader economy. They determine how trillions of dollars of loans, mortgages and derivatives are priced.
Barclays has admitted that from 2005 to 2007, individual traders nudged LIBOR both higher and lower to suit the investments they were holding in their trading books. They did this in order to maximize their profits. Traders get bonuses based on their profits and losses, and some couldn’t resist the temptation to massage their results to show the biggest gains possible.
And from 2007 through 2011, Barclays deliberately pushed LIBOR down, partly to make it appear that the bank’s borrowing prospects were better than they were during the global financial crisis.
The revelations have triggered a political furor in the U.K.— but nothing comparable, so far, in the U.S. But this might soon change if a two-year investigation concludes that any U.S. reference bank — including Bank of America, Citibank and J.P. Morgan Chase, or even all three – was in on the fix.
Misguided pundits have rushed to explain the lack of widespread outrage here in the U.S. The New Republic’s Noam Scheiber believes that no one’s complaining because LIBOR fixing was a so-called "victimless crime" in which individuals benefited from lower borrowing rates, while corporations— if they even noticed the manipulations— were also able to borrow at lower rates and so had no incentive to blow the whistle. According to this view, banks kept quiet because the net gains and losses were confined to the banking community where a code of omerta prevails, so long as the consequences remain within the family.
The Daily Beast’s Zachary Karabell goes one step further and blames the victims for shirking responsibility for poor borrowing decisions. He believes that if borrowers—including institutions, pension funds and municipalities-- had practiced a "buyer beware" approach, we wouldn't have the mess, even though he concedes that “LIBOR is the very definition of a rate set by a cabal, ripe for collusion.”
Both these explanations are dead wrong. There are victims in this crime, all right. And those victims are not to blame for bank fraud.
Who lost out, big time, from fixing these rates? Grandma, that’s who! The multiyear pattern of setting LIBOR too low screwed her in six ways. Her finances will almost certainly never recover from the experience. And, needless to say, she never asked for it.
1. Lower LIBOR reduced rates of return on prudent investments. Two general principles dictate investment patterns during a person’s lifetime. First, as a general rule, people borrow during household formation, save (or invest) as empty nesters, and then spend their savings and investment income during retirement, along with any pensions. Second, investment patterns also change throughout an individual’s lifetime. People invest more aggressively in shares of stock, for example, earlier in life, and then shift into less risky fixed income investments as they age.
When you’re young, you can afford to assume greater risk in order to chase potentially greater investment returns. But as you get older, preserving your capital becomes more important. Prudent investment advice therefore directs older people and retirees into retail bank certificates of deposit, which are priced based on LIBOR benchmarks. So are most money market funds. But following this conventional wisdom has proven to be a bust for Grandma. LIBOR manipulation caused her income to drop by as much as 2 percent.