Barclays and the Bank of England: BAD rate-rigging and GOOD rate-rigging

The Barclays rate-rigging scandal has conflated a number of issues — Bob Diamond’s bonus, ‘casino’ banking, failed regulators — making it hard to get behind the media’s shouty headlines to understand the issues which should really concern us. Here’s my brief show-your-working attempt, starting with what Barclays.

What Barclays did right: ‘fess up

LIBOR (London Inter Bank Offered Rate) is the rate at which banks in London lend money to each other for the short-term. It’s used as a proxy measure of market confidence in individual banks, as well as a benchmark for setting mortgage interest rates.

Barclays has admitted filing misleading figures for interbank borrowings they made between 2005 and 2009, and as a result been landed with a £290m fine. It’s unlikely Barclays were the only bank to attempt to rig LIBOR. But they are the first to admit it, as the investigating US department of justice’s statement made clear:

To the bank’s credit, Barclays also took a significant step toward accepting responsibility for its conduct by being the first institution to provide extensive and meaningful cooperation to the government. Its efforts have substantially assisted the Criminal Division in our ongoing investigation of individuals and other financial institutions in this matter … After government authorities began investigating allegations that banks had engaged in manipulation of benchmark interest rates, Barclays was the first bank to cooperate in a meaningful way in disclosing its conduct relating to LIBOR and EURIBOR.

It’s certainly true that Barclays’ cooperation resulted in a slightly reduced fine and the avoidance of corporate criminal prosecution (though employees were not granted immunity). But the bullet Barclays dodged there has ricocheted to hit its reputation squarely between the eyes. Barclays are now paying a heavy ‘first mover penalty’ as a result of the horrendous publicity they’ve attracted, exacerbated by the controversy over Bob Diamond’s infamous bonus payments.

What Barclays — and almost certainly other banks — did wrong: rate-rigging

There appear to be two distinct phases to their rate-rigging:

  • 2005 to 2008: Barclays, sometimes working with traders at other banks, tried to influence the Libor rate – so as to try to boost their profits;
  • 2007 to 2009: at the height of the global banking crisis, Barclays filed artificially low figures in an attempt to hide the level to which Barclays was under financial stress.

I think we can safely say the first of these is clearly bad and wrong, and quite possibly illegal.

There’s more controversy over the second, and in particular the suggestion that the government via the supposedly independent Bank of England ‘tipped the wink’ to Barclays to rate-rig at a time when the UK banking sector was teetering. It is alleged that Paul Tucker, the Bank of England’s deputy governor and top insider-contender for the top job when Sir Mervyn King steps down, phoned Bob Diamond in 2008…

… wanting to know why the estimated borrowing rates that Barclays fed into Libor calculations were relatively high. Mr Diamond said other banks declared rates lower than their real borrowing costs. Mr Tucker, who resembles a cerebral Winnie the Pooh, then allegedly implied that there would be no real harm in Barclays joining in. (FT.com, 3 July 2012)

At first glance the data is suggestive:

(Graph from FT.com, captured by @SuttonNick)

But Barclays is one of many banks whose rates are used to calculate LIBOR — any one bank’s impact on the overall LIBOR rate will be small. Yet as we can see, LIBOR fell markedly from the autumn of 2008, so Barclays were not outliers in lowering their rates:

(Graph from kshitij.com)

We have, therefore, one clear infringement by Barclays motivated by a desire to rig rates for profit (2005-08). We then have a further infringement by Barclays (and probably others) motivated it seems by a desire to shore up confidence in the banking system, perhaps with the implicit/explicit agreement of the Bank of England (2007-09).

When GOOD rate-rigging goes BAD

Motivation is a key point here. Rate-rigging for corporate profit is clearly bad. But what do we think about rate-rigging to prop up confidence in the banking sector? Is that also de facto bad?

Or is it better — or at any rate less bad — than the alternative, a collapse of confidence in banks and the freezing up of lending with all that implies for the economy?

I ask because rate-rigging with good intentions has been the policy of the UK government and Bank of England for many years. Jock Coats has drawn attention to former Bank of England governor Sir Edward George’s explicit admission of this in 2008:

“In the environment of global economic weakness at the beginning of this decade… external demand was declining and related to that, business investment was declining … We only had two alternative ways of sustaining demand and keeping the economy moving forward – one was public spending and the other was consumption. We knew that we were having to stimulate consumer spending. We knew we had pushed it up to levels which couldn’t possibly be sustained into the medium and long term. But for the time being, if we had not done that, the UK economy would have gone into recession just as the United States did.”

You won’t get a much simpler explanation than that of the current economic carnage. The government and the Bank initiated a short-term, well-intentioned aim of debt-fuelled stimulus (both individual and government) to prevent an economic downturn a decade ago.

They were then content to ignore the build-up of pressures in the economy that resulted, with the government’s instruction to the Bank of England to target retail inflation and to ignore asset price inflation allowing individual borrowing to let rip:

(Graph from Tim Morgan, The Quest for Renewal and Change (p.12), Centre for Policy Studies.)

Access to cheap-and-too-easy credit — fuelled in turn by ever-higher public spending — stoked an wholly artificial Ponzi-style economic boom which has now, inevitably, collapsed into a pile of rubble. The intentions of this rate-rigging were good, and never out of any desire for personal profit. But the consequences have been devastating, with individual and government debt continuing to weigh the economy down.

* Stephen was Editor (and Co-Editor) of Liberal Democrat Voice from 2007 to 2015, and writes at The Collected Stephen Tall.

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15 Comments

  • Mack (Not a Libd Dem 4th Jul '12 - 4:30pm

    The inquiry into the LIBOR scandal should not only be speedy, it should be thorough. That is why a judicial inquiry is essential. It should not be entrusted to ignorant and inept MPs who have no cross examination skills and whose party may be being funded by bankers.

  • Just a small correction – Eddie George made his admission in March 07 in oral evidence to a Treasury Select Committee investigation into the first five years’ operations of the Monetary Policy Committee. So far as I am aware it was only ever picked up on by one newspaper (The Indie) despite the apparent importance of the revelation (presumably because the context was not about rate setting or economic catastrophe but what motivated the MPC). I’ve been banging on about it ever since because I think they missed a big trick that would have helped them understand the whole crisis better.

  • Richard Dean 4th Jul '12 - 6:13pm

    Bob Diamond’s testimony this afternoon mentioned three phases, rather than two. Perhaps the third was something else.

    I have to admit that the graphs are puzzling. The second graph suggests that the primary driver of LIBOR is the Bank of England interest rate.When it went down by 4.5 percent, LIBOR did too. By comparison , the first graph shows Barclays a mere 0.15% higher before the big change, and only about 0.1% lower on average in the month after.

    Bob Diamond’s explanation this afternoon was that they were finishing some kind of private capitalization project at that time, and that once the project was completed, the market became much more confident about Barclays, and this in turn meant that Barclays could borrow from other banks at a significant discount – hence the relative high in October (lack of market confidence that the project would succeed) and the relative low in November (confidence once it had succeeded) in the first graph.

    Is this aspect of Diamond’s evidence believable?

  • Thanks for explaining it clearly, Stephen.

  • Just to prove context sensitive Google Ads do work, the current one under Margaret’s post for me is:

    You Could Be Owed £2400
    If You’ve Ever Had Any Loans. You Could Be Owed A Refund
    Barclays.UKs1.com

  • Bill le Breton 4th Jul '12 - 9:43pm

    The “inquisition” by the Select Committee today was predictably was embarrassing. If anything meaningful is to come from an inquiry it cannot be left to Parliamentarians, sadly.

    And it must be meaningful. Getting regulation and monetary policy wrong has been a disaster … on a global scale. Going too far or getting inappropriate regulation will prevent recovery, as will the continuing tight monetary policy that is suppressing the western economies today.

    We had recovery from the dot.com bust by loosening monetary policy. Quite an achievement, really. But this policy was continued long after the ‘medicine’ had done its work. From 2007 onwards as commodity prices rose and deleveraging began, targeting the inflation forecast caused monetary policy to be tightened just when it needed to be loosened again.

    NGDP targeting, level targeting, would not have led to this as the commodity prices rises would not have led to tightening.

    From that moment on, including to the present, the Bank of England has been depressing the UK economy, turning a recession into a Great Recession. Ditto the Fed, the Bank of Japan and the ECB.

    The incompetence of central bankers and regulators should be dealt with by sacking them. Yet we continue to allow them to run this vital part of public affairs and even to promote them.

  • Richard Dean 4th Jul '12 - 9:52pm

    One person’s incompetence is another’s deliberate course towards a defined goal. I wonder what that goal might have been?

  • Bill le Breton 4th Jul '12 - 10:35pm

    Richard, do you think the 2007 rate rises were wise? Have a look at the graph provided by Stephen.

  • All rate rigging is wrong. The correct path if the BoE thinks a bank will go under is emergency loans from the BoE/HMT, perhaps even for an equity stake so that taxpayers get an upside.

  • Richard Dean 4th Jul '12 - 11:08pm

    I am asking what might the motive have been if it was not incompetence, but was instead a deliberate and aware choice.

  • Richard Dean 4th Jul '12 - 11:21pm

    But LIBOR was almost designed to be rigged!

    I am given to understand that it’s not a measure of fact, but of opinion. It’s an average of the rate bankers THINK they might be offered if they asked other bankers for a loan. The system developed in such a way that those other bankers then offered rates related to the LIBOR. This means you get what you think you get, and you can alter what you get by altering what you think you can get. Crazy! And very open to fiddles.

    Instead of wailing when someone takes advantage of an opportunity to fiddle, and instead of having the expense of policing an easily fiddled system, wouldn’t it be better to re-design the system so that those opportunities don’t arise?

    Listening to Bob today, I started wondering whether Paul Tucker might have been saying the same things to other banks too, in an attempt to get the LIBOR down. If Barclays thought that , it might have given them a valid reason to reduce their submissions. But perhaps not one that might be easily defended in that committee forum.

  • Paul in Twickenham 5th Jul '12 - 8:07am

    I would ask the Alistair Campbell question: “Why that memo, why now?”

    The memo (which is dated October 29th, 2008 – right at the height of the crisis) clearly indicates that someone in government demanded that Barclays lower their LIBOR rate. It’s easy to imagine Gordon Brown telling Mervyn King to get Barclays to lower their LIBOR submission because he doesn’t want any suggestion that Barclays is vulnerable as that would be disastrous.

    And sure enough, Barclays submitted LIBOR rate then rapidly falls. But hold on! At exactly that time the Qataris stepped in and put $7bn into Barclays, so of course their risk premium would be expected to fall, exactly as happened!

    I am of the view that Barclays chose to put this memo into the public domain right now in order to generate exactly this analysis. However it does nothing to explain the previous 3 years of LIBOR manipulation (which was certainly about generating bookable – and therefore bonusable – profit).

    And the fact that Barclays was in the top decile of LIBOR submissions just prior to the Qatari investment is in itself somewhat odd and probably warrants further investigation.

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