Barclays’ Chief Executive, Bob Diamond, has resigned following revelations that Barclays staff had been involved in rigging the LIBOR in the period 2005–9, including the financial crisis of 2007–9.
So what is the LIBOR; how is it set; what were the reasons for Barclays (and other banks, as will soon be revealed) attempting to manipulate the rate; and what were the consequences?
The LIBOR, or London interbank offered rate, is the average of what banks report that they would have to pay to borrow from one another in the inter-bank market. Separate LIBORs are calculated for 15 different lending periods: overnight, one week, one month, two months, three months, six months, etc. The rates are set daily as the average of submissions made to Thomson Reuters by some 15 to 20 banks (a poll overseen by the British Bankers’ Association). Thomson Reuters then publishes the LIBORs, along with all of the submissions from individual banks which are used to calculate it.
Many interest rates around the world are based on LIBORs, or their European counterpart, EURIBORs. They include bond rates, mortgage rates, overdraft rates, etc. Trillions of dollars worth of such assets are benchmarked to the LIBORs. Thus manipulating LIBORs by even 1 basis point (0.01%) can result in millions of dollars worth of gains (or losses) to banks.
The charge, made by the Financial Services Authority, is that Barclays staff deliberately under- or overstated the rate at which the bank would have to borrow. For example, when interbank loans were drying up in the autumn of 2008, Barclays staff were accused of deliberately understating the rate at which they would have to borrow in order to persuade markets that the bank was facing less difficulty than it really was and thereby boost confidence in the bank. In other words they were accused of trying to manipulate LIBORs down by lying.
As it was the LIBORs were rising well above bank rate. The spread for the one-month LIBOR was around 1 to 1.2% above Bank Rate. Today it is around 0.1 to 0.15% above Bank Rate. Without lying by staff in Barclays, RBS and probably other banks too, the spread in 2008 may have been quite a bit higher still.
The following articles look at the issue, its impact at the time and the aftermath today.
Articles
A Libor primer The Globe and Mail, Kevin Carmichael (3/7/12)
60 second guide to Libor Which? (3/7/12)
Explaining the Libor interest rate mess CNN Money (3/7/12)
Fixing Libor Financial Times (27/6/12)
LIBOR in the News: What it is, Why it’s Important Technorati, John Sollars (2/7/12)
Libor rigging ‘was institutionalised at major UK bank’ The Telegraph, Philip Aldrick (1/7/12)
Barclays ‘attempted to manipulate interest rates’ BBC News, Robert Peston (27/6/12)
The Libor Conspiracy: Were the Bank of England and Whitehall in on it? Independent, Oliver Wright, James Moore , Nigel Morris (4/7/12)
Fixing LIBOR The Economist (10/3/12)
Cleaning up LIBOR? The Economist (14/5/12)
Eagle fried The Economist, Schumpeter (27/6/12)
Barclays looks like the victim Financial Post, Terence Corcoran (3/7/12)
Inconvenient truths about Libor BBC News, Stephanie Flanders (4/7/12)
Timeline: Barclays’ widening Libor-fixing scandal BBC News (5/7/12)
The elusive truth about Barclays’ lie BBC News, Robert Peston (4/7/12)
Rate Fixing Scandal Is International: EU’s Almunia CNBC, Shai Ahmed (4/7/12)
Bank-Bonus Culture to Blame for Barclays Scandal The Daily Beast, Alex Klein (3/7/12)
Libor scandal ‘damaging’ for City BBC Today Programme, Andrew Lilico and Mark Boleat (5/7/12)
Data
Libor rate fixing: see each bank’s submissions Guardian Data Blog, Simon Rogers (3/7/12)
Sterling interbank rates Bank of England
Questions
- Using data from the Bank of England (see link above), chart two or three LIBOR rates against Bank rate from 2007 to the present day.
- For what reason would individuals and firms lose from banks manipulating LIBOR rates?
- Why would LIBOR manipulation be more ‘effective’ if banks colluded in their submissions about their interest rates?
- Why might the Bank of England and the government have been quite keen for the LIBOR to have been manipulated downwards in 2008?
- To what extent was the LIBOR rigging scandal an example of the problem of asymmetric information?
- In the light of the LIBOR rigging scandal, should universal banks be split into separate investment and retail banks, rather than erecting some firewall around their retail banking arm?
- What are the arguments for and against making attempts to manipulate LIBOR rates a criminal offences?
No market is perfect and when the market mechanism fails to deliver an efficient allocation of resources, we say the market fails and hence there is justification for some government intervention. From a monopolist dominating an industry to a manufacturing firm pumping out pollution, there are countless examples of market failure.
The Guardian is creating a guide to climate change, covering areas from politics to economics. The problem of climate change has been well documented and this blog considers a particular issue – the case for climate change or the environment as a market failure. In many cases just one market failure can be identified, for example an externality or a missing market. However, one of the key problems with climate change is that there are several market failures: externalities in the form of pollution from greenhouse gases; poor information; minimal incentives; the problem of the environment as a common resource and the immobility of factors of production, to name a few. Each contributes towards a misallocation of resources and prevents the welfare of society from being maximised.
When a market fails, intervention is justified and economists argue for a variety of policies to tackle the above failures. In a first-best world, there is only one market failure to tackle, but in the case of the environment, policy must be designed carefully to take into account the fact that there are numerous failings of the free market. Second-best solutions are needed. Furthermore, as the problem of climate change will be felt by everyone, whether in a developed or a developing country, international attention is needed. The two articles below are part of the Guardian’s ultimate climate change guide and consider a huge range of economic issues relating to the problem of environmental market failure.
Why do economists describe climate change as a ‘market failure’? Guardian, Grantham Research Institute and Dunca Clark (21/5/12)
What is the economic cost of climate change? Guardian (16/2/11)
Questions
- What is meant by market failure?
- What are the market failures associated with the environment and climate change? In each case, explain how the issue causes an inefficient allocation of resources and thus causes the market to fail? You may find diagrams useful!
- What is meant by the first-best and second-best world?
- What does a second-best solution aim to do?
- Using diagrams to help your explanation, show how a tax on pollution will have an effect in a first best world, where the only market failure is a negative externality and in a second best world, where the firm in question is also a monopolist.
- What solutions are there to the problem of climate change? How effective are they likely to be?
- Does the need to tackle climate change require international co-operation? Can you use game theory to help your explanation?!
A recent post on this blog referred to what sounds a fascinating new book, What Money Can’t Buy: The Moral Limits Of Markets, by Michael Sandel. The Guardian also recently featured an extract from this book.
As the earlier blog post discussed, our lives are now dominated by markets. Economists typically believe markets are the best way to allocate resources as, if the market mechanism works correctly, the resulting equilibrium maximizes economic welfare as measured by the sum of consumer and producer surplus. In particular, all consumers that are willing to pay a price above the market price are able to buy the product.
Fundamental to the measurement of consumer welfare is the notion that consumers will be prepared to buy a product as long as their willingness to pay exceeds the price. It therefore follows that consumers are more likely to buy the product as the price falls and, if they do so, gain increasing surplus. However, the extract from Michael Sandel’s book provides a number of interesting examples which suggest that in some situations this might not be the case.
One example concerns the storage of nuclear waste in Switzerland. When surveyed, 51% of the residents of the small Swiss village of Wolfenschiessen, said that they would be prepared to accept the waste being stored nearby. However, somewhat surprisingly, this figure fell to 25% when the residents were told that they would be compensated for the inconvenience. Furthermore, the figure remained at this low level even when the proposed compensation was increased to over £5000 per person.
Sandel argues that this is because, once compensation is introduced, financial incentives crowd out public spirit. He suggests that:
putting a price on the good things in life can corrupt them.
For economists, this potentially has important implications for how we evaluate market outcomes and our belief that the market equilibrium is always the optimal outcome. Furthermore, it suggests that in some circumstances allowing the market mechanism to allocate resources may not be the ideal solution.
Articles
What money can’t buy – review The Guardian, John Lanchester (17/05/12)
Michael Sandel: ‘We need to reason about how to value our bodies, human dignity, teaching and learning’ The Guardian, Decca Aitkenhead (27/5/12)
We must decide on the way we want to live now London Evening Standard, Matthew d’Ancona (23/05/12)
Questions
- How is consumer surplus calculated?
- How does the market mechanism allocate resources?
- How would you explain the responses of the residents in the Swiss village?
- Do you think the Swiss residents would respond in the same way if the compensation offered was increased even further?
- What type of products and services do you think might be less well suited to being provided by markets?
Here’s a question that goes to the heart of economics and the social sciences generally: how desirable is the market system?
Our lives are dominated by markets. Whether in working or consuming, we operate in a market economy in which money is exchanged for goods or services. But also financial and product markets determine much of the structure of society, where most things seem to have a price.
But whilst, as a positive statement, we can say that money and markets are all around us, does that make them desirable? Markets provide signals and incentives; but are the signals the right ones? What are the incentives and how do we respond to them? And are these responses optimal?
You will probably have studied various ways in which markets fail to provide the optimal allocation of resources. But what are the limits of markets as a mechanism for social choices? And is there some more fundamental issue about the morality of a society that is organised around markets?
These are questions considered in the following podcast. It is an episode from BBC Radio 4’s Start the Week programme, hosted by Andrew Marr, with guests Michael Sandel, Diane Coyle and Grigory Yavlinksy. Here are the programme details:
Andrew Marr discusses the relationship between markets and morals with the political philosopher Michael Sandel. In his latest book, What Money Can’t Buy, Sandel questions the dominance of the financial markets in our daily lives, in which everything has a price. But the economist Diane Coyle stands up for her much maligned profession, and points to the many benefits of a market economy. The Russian economist Grigory Yavlinksy argues against viewing the world of money as separate from culture and society: he believes the financial crisis was merely a symptom of a wider moral collapse, and that it is time to examine the way we live.
(Links to the three contributors: Michael Sandel, Diane Coyle (see also), Grigory Yavlinsky.)
Podcast
Michael Sandel on Money and Morality BBC Start the Week programme (21/5/12)
Videos and articles
For a range of videos and articles on the morality of capitalism, see the previous post at:
We need to talk about Capitalism (28/1/12)
Questions
- What crises are there in current capitalism?
- What, according to Michael Sandel, is the difference between a market economy and a market society?
- Is the market society a relatively new phenomenon, or does it go back hundreds of years?
- To what extent is the greed expressed through markets and encouraged by markets affecting/infecting society and human relationships generally?
- What is the role of morality and trust in determining the desirability of market relationships?
- To what extent does a market economy allow people, rich and poor, to live separately from each other and not interact as joint members of society?
- What are the value systems promoted by marketisation? Should certain aspects of human life be outside these value systems?
- To what extent is the crisis of capitalism a crisis of economics?
- What policy alternatives are there for rebalancing society?
- What is the role of economists in advising on policy alternatives?
The Office for Budget Responsibility has said that the UK Treasury will face a shortfall of £13bn in motoring taxes within a decade. Although car usage continues to rise putting increasing pressure on the road infrastructure, the greener and more fuel efficient cars being produced are driving down the tax revenues generated from motoring.
A report by the IFS has put forward the case for replacing the existing system of taxes on cars and fuel by a new road charging system. If no such change occurs, the IFS has forecast that with more electric cars and hence lower revenues raised from fuel and vehicle excise duties, the shortfall facing the Treasury would require an increase in fuel duty of some 50%. Instead of this, the solution could be to charge individuals for every mile of road they use, with the ‘price’ varying depending on the degree of congestion. For example, at peak times the price would be higher, where as for those in the countryside where roads are traditionally much quieter, charges would be lower. The IFS said:
‘Such a move would generate substantial economic efficiency gains from reduced congestion, reduce the tax levied on the majority of miles driven, leave many (particularly rural) motorists better off, and provide a stable long-term footing for motoring taxes without necessarily raising net additional revenue from drivers.’
Government policy across the world has been increasingly focused on climate change, with targets for emissions reductions being somewhat ambitious. However, many car manufactures who were told to reduce emissions significantly are on the way to meeting these targets and this success is a key factor contributing towards this new road ‘crisis’ that could soon be facing the government. The following articles consider the possibility of a road charging scheme.
Report
The road ahead for motoring taxes? Institute of Fiscal Studies (link to full report at the bottom of the page) (May 2012)
Articles
Compelling case for UK road charging, IFS study says BBC News (15/5/12)
Fears tax shortfall may lead to road tolls Sky News (15/5/12)
Who’s going to pay to update Britain’s infrastructure? Guardian Business Blog (15/5/12)
Motoring taxes: a future headache for the Chancellor Channel 4 News (15/5/12)
For whom the toll bills – less traffic hurts M6 toll road owner Guardian, Ian Griffiths and Dan Milmo (14/5/12)
Charge motorists per mile, says IFS Independent, Nigel Morris (15/5/12)
Green cars to drive down tax receipts Financial Times, Mark Odell and John Reed (15/5/12)
Questions
- Illustrate the effect of a tax being imposed on petrol. What happens to the equilibrium price and quantity?
- Despite fuel duty pushing up the price of petrol, why has there been such a small decline in the quantity of petrol individuals use?
- Evaluate the case for and against a road charging scheme.
- Why are tax revenues from motoring expected to decline over the next decade?
- Climate change has become an increasingly important focus of government policy. To what extent is the current road ‘crisis’ a positive sign that policies to tackle climate change are working?
- If a road charging scheme went ahead and prices were varied depending on traffic, time etc, what name would you give to this strategy?
- Why would it be possible to charge a higher price at peak times and a lower price for cars using country roads?
- Is there an argument for privatising the road network? Is it even possible?
The charge, made by the Financial Services Authority, is that Barclays staff deliberately under- or overstated the rate at which the bank would have to borrow. For example, when interbank loans were drying up in the autumn of 2008, Barclays staff were accused of deliberately understating the rate at which they would have to borrow in order to persuade markets that the bank was facing less difficulty than it really was and thereby boost confidence in the bank. In other words they were accused of trying to manipulate LIBORs down by lying.
