The LIBOR scandal explained
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Submitted by a little night ... on Wed, 07/11/2012 - 1:40pm
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Corrente
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Barbarossa ruin, Nijmegen, The Netherlands
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Still confusing
I wish rather than using the "Thomson Reuters" graphic, that he had used the pension fund graphic, plus that he had used dollar signs going between the Member Banks.
If I have this right, to avoid raising the LIBOR rate (the official rate banks would have to pay), the banks colluded to lend money secretly between themselves and set artificially low rates by doing so. If they had shared that information with the people who calculated the LIBOR, it would have raised the rate they would have had to pay pension funds, mutual funds, bonds, etc. for other monies they borrowed under the LIBOR rate.
Is this right?
The banks lied about the rates they were paying (apparently)
You say: "If they had shared that information" - The point is that they apparently lied about the rate at which they were borrowing, which meant that the LIBOR rate was artificially low (and P.S., the banking system looked stronger than it actually was) and this had a downstream effect on other financial instruments.
ETA: they weren't paying lower rates, they lied and said they were paying lower rates than they were paying.
Ok, regarding LIBOR
So what you are saying is they were borrowing from each other at higher rates and in larger amounts than they were telling LIBOR they were borrowing at? Then when they would borrow from LIBOR (i.e. pension funds, municipal bonds, etc.), they would therefore pay a lower rate for those than they would have? Is that right?
There seem to be two layers to the LIBOR scandal
One is like a background radiation aspect: They're all just gaming and manipulating the rate, and then trading (gambling) on the manipulation. That's been going on since well before the financial crisis. I want to say 2003, but I'm not sure where I picked that date up.
The second is the 2008 scandal. LIBOR is an average of rates submitted by member banks. It is the rate a bank believes it would be charged by another bank to borrow money.
So, if a bank submits a high rate, that implies that it believes that other banks believe it is risky.
So a bank that is in trouble, but wishes to conceal that fact, would submit an artifically low rate (!!!). Which is what Barclays did in the 2008 crisis.
What Lambert said
Sorry, I missed your reply when I replied!
So I should have said
Yes, yes, my second phrase should have read, "When they paid on the financial instruments whose rates were set by LIBOR (not "borrowed from LIBOR), that rate was artificially low since they were colluding to understate the rate at which they were borrowing".
Sorry, my bad.
No, they probably repaid at the rates they agreed to privately
That's not the problem. The problem is (at least) twofold:
1) The falsely low reported rates made the borrowing banks look healthier than they actually were (as Lambert said)
2) The artificially low LIBOR meant that interest rates on other financial instruments (such as derivatives) which are keyed to LIBOR were set too low, and the investors in those instruments (including state and local governments, pension other financial institutions such as TIAA-CREF, etc.) were therefore paid less than they should have been.
So the banks' attempt to make themselves look less unhealthy than they were ended up costing the investors in those instruments, meaning they had less money to spend on services and salaries of public workers, etc.
That's basically what the pictures are showing.
They don't borrow from LIBOR
LIBOR is the average rate, not a place or a bank.
See Wikipedia, for example.