By John Ballard
Heard about the LIBOR scandal? At this point the magnitude of possible damage is unknown. But what is known is as unsettling as finding out your doctor is strung out on drugs or your baby sitter's boyfriend is a registered sex offender. Some stuff just makes you uncomfortable just thinking about it.
What's the most basic service banks provide? Borrow money and lend it out. You put your savings in a bank to hold in trust, and the bank agrees to pay you interest on it. Or you borrow money from the bank and you agree to pay the bank interest.
How is this interest rate determined? We trust that the banking system is setting today's rate based on its best guess about the future worth of the money. And we assume that guess is based, in turn, on the cumulative market predictions of countless lenders and borrowers all over the world about the future supply and demand for the dough.
But suppose our assumption is wrong. Suppose the bankers are manipulating the interest rate so they can place bets with the money you lend or repay them - bets that will pay off big for them because they have inside information on what the market is really predicting, which they're not sharing with you.
That would be a mammoth violation of public trust. And it would amount to a rip-off of almost cosmic proportion - trillions of dollars that you and I and other average people would otherwise have received or saved on our lending and borrowing that have been going instead to the bankers. It would make the other abuses of trust we've witnessed look like child's play by comparison.
Sad to say, there's reason to believe this has been going on, or something very much like it. This is what the emerging scandal over "Libor" (short for "London interbank offered rate") is all about.
Libor is the benchmark for trillions of dollars of loans worldwide - mortgage loans, small-business loans, personal loans. It's compiled by averaging the rates at which the major banks say they borrow.
So far, the scandal has been limited to Barclay's, a big London-based bank that just paid $453 million to U.S. and British bank regulators, whose top executives have been forced to resign, and whose traders' emails give a chilling picture of how easily they got their colleagues to rig interest rates in order to make big bucks. (Robert Diamond, Jr., the former Barclay CEO who was forced to resign, said the emails made him "physically ill" - perhaps because they so patently reveal the corruption.)
I already knew about the London Interbank Offered Rate because before we refinanced our mortgage last time it was an adjustable rate mortgage (ARM) and the rate which would trigger a change at the appointed time was based on LIBOR. Wow, I thought. Those Brits are so solid they not only set the time in Greenwich, they also set interest rates for the whole global financial system.
Boy was I wrong about that. Well, not exactly... Apparently LIBOR really IS the global anchor. But unlike Greenwich Mean Time it's not based on the scientific arithmetic used to calibrate clocks so they don't drift too fast or too slow. It's derived from the arcane arithmetic of economics, also called the Dismal Science. It's not exactly a Ponzi scheme, but what's been revealed so far doesn't pass the smell test.
Reich goes on to say...
But Wall Street has almost surely been involved in the same practice, including the usual suspects - JPMorgan Chase, Citigroup, and Bank of America - because every major bank participates in setting the Libor rate, and Barclay's couldn't have rigged it without their witting involvement.
In fact, Barclay's defense has been that every major bank was fixing Libor in the same way, and for the same reason. And Barclays is "cooperating" (i.e., giving damning evidence about other big banks) with the Justice Department and other regulators in order to avoid steeper penalties or criminal prosecutions, so the fireworks have just begun.
There are really two different Libor scandals. One has to do with a period just before the financial crisis, around 2007, when Barclays and other banks submitted fake Libor rates lower than the banks' actual borrowing costs in order to disguise how much trouble they were in. This was bad enough. Had the world known then, action might have been taken earlier to diminish the impact of the near financial meltdown of 2008.
What to do about it, other than hope the Justice Department and other regulators impose stiff fines and even criminal penalties, and hold executives responsible?
When it comes to Wall Street and the financial sector in general, most of us suffer outrage fatigue combined with an overwhelming cynicism that nothing will ever be done to stop these abuses because the Street is too powerful. But that fatigue and cynicism are self-fulfilling; nothing will be done if we succumb to them.
The alternative is to be unflagging and unflinching in our demand that Glass-Steagall be reinstituted and the biggest banks be broken up. The question is whether the unfolding Libor scandal will provide enough ammunition and energy to finally get the job done.
Which brings us now to ZIRP.
First, what does it mean?
ZIRP is an acronym for Zero Interest Rate Policy. Sounds harmless enough, of course.
In fact it sounds like free beer if you're in the market for some borrowed money.
ZIRP seems to have corresponded with the financial crisis of 2008. Using a variety of accounting tricks the banking system, aided and abbetted by the Federal Reserve, have been able to get their hands on what is basically free money.
We know about the famous bank bailouts, set in motion during the last administration and continued by the one coming into office. Since I haven't heard a peep from any Republicans about this policy, I have to conclude ZIRP must have bipartisan support. Heck, who complains about cheap money?
I'll tell you who complains. Anybody who has saved and expects to be collecting interest on their savings, that's who.
Allow me to introduce the Oldster Tax. It is a tax for which there is no legislation. It is a tax that is not administered by the Internal Revenue Service. Instead, it has been imposed by the Federal Reserve, an institution that has the power to set interest rates.
The folks at the Fed don't call it a tax, however. They call it a policy -- ZIRP, for zero-interest-rate policy.
Low interest rates are a two-edged sword. It's great if you are a young borrower. A low-interest-rate mortgage means you can buy a bigger house. A low-interest-rate car loan means you can buy a more expensive car. The hope at the Federal Reserve is that young borrowers will splurge and stimulate the economy with their borrowing.
Sadly, the sword cuts the other way if you are a retired saver. After decades of saving, millions of oldsters are discovering that their savings earn next to nothing. Savings earn less than nothing if you consider inflation and taxes. Basically, the Federal Reserve has been trying to boost the confidence and living standard of the young -- and paying for it by attacking the living standard of the old.
Can you avoid the Oldster Tax? Yes. Be poor. Have no savings.
I'm reminded of Alan Grayson's version of the GOP healthcare proposal.
1. Don't get sick.
2 and if you do get sick...
3 Die quickly.
Since 2008, the Fed has manipulated interest rates to near zero percent, thereby depressing the yields on fixed income investments like bonds (NYSEArca: AGG) and savings accounts. And the Fed's extension of Operation Twist through the end of this year is more of the same.
Here's the translation: Savers are being penalized, speculators are being rewarded. On June 1, the yield on 10-Year Treasury (NYSEArca: IEF) notes fell to a record low of 1.43%.
The best 7-day yield on a retail money market fund (Nasdaq: FSLXX), according to Crane Data, is a paltry 0.10%. Tax exempt money funds (Nasdaq: MOFXX) yield slightly more, but mounting muni credit risk has everybody but Paul Krugman rightly on edge. A top yielding 5-year certificate of depression (CD) will snag you around 1.69%. At that interest rate, it'll take you approximately 42 years to double your money. As a result, conservative income investors, at a record rate, are piling into volatile but high yielding asset classes like junk bonds (NYSEArca: HYG), preferred stock (NYSEArca: PFF), exotic emerging market debt (NYSEArca: PCY) and other high risk areas they wouldn't have dreamed of touching in past years. The net cash flow into HYG, which tracks low rated corporate bonds, has more than doubled over the past year! History doesn't always repeat itself, but it often rhymes.
People who chased yields in highly leveraged mortgage REITs (NYSEArca: REM) got crushed when the group collapsed by 42% in value in 2008, not to mention the wave of dividend cuts they suffered. Before that time, mortgage REITs were sold as a reliable source of income.
I want to end this post with words of advice or encouragement. Failing that, ever a few good sarcastic lines would at leat make me feel better. But unfortunately I can't think of either. If there were anything positive to say we would already be hearing it from at least one of the two presidential candidates. Instead the best we can hope for from that quarter are criticisms of each other and what politicians call "positioning" on this or that policy. This exchange I saw last night on a Facebook post says it all.
Child: Mommy, do fairy tales always start with "Once upon a time?"
Mom: No, dear. Politicians always start with "After I am elected..."
Just today I have heard everyday people calling in to both radio and TV revealing a breathtaking depth of ignorance and misunderstanding. There is virtually no recognition that the economic problems now in the news are but America's share of a global slowdown over which no one country or individual has any meaningful control, rendered more complicated by a debt-based global financial network made dangerously unstable by exotic (toxic, really) mixtures of risk-taking through hedge funds, derivatives, credit default swaps and futures speculation which make old-fashioned options trading look like a game of checkers. Not to mention high-speed transactions executed by computer programs such as precipitated the "flash crash" of May 6, 2010.
Vast numbers of people are just starting to realize there is a presidential election going on this year. Many have been listening to half an ear and have more misinformation that could be corrected in the next 120 days, even if both campaigns didn't deliberately propagate misleading suggestions and outright lies leading up to November. Barring unforeseen circumstances I expect the GOP to have an overwhelming funding advantage which will manifest in a blistering assault on Obama resulting in Romney's election. He may pull another rabbit from his hat, but without a financial advantage his chances of winning, even with a rabbit, are seriously diminished.
That is not, of course, my preference. But I am trying to be realistic. If I have learned nothing else in life it is that beliefs trump facts. It makes no difference if global warming is not only real but caused in large part by ungoverned human misbehavior. As long as enough people believe otherwise, that reality will have no more importance than an office pool aiming for the Mega-Millions jackpot.