Opacity and the Libor Investigation

I apologize for being several days late on discussing the Libor investigation.  As Gillian Tett noted as she peered into the dark corners of finance in her excellent Financial Times column, setting the Libor rate is another example of where opacity in the financial system has potentially allowed banks to manipulate prices in their favor.

This week it has emerged that almost a dozen traders and brokers around the world have been fired, suspended, or put on leave, amid a multinational probe into alleged manipulation of Libor. 

In particular, there are allegations that financial players have colluded to influence these rates, which serve as a benchmark for some $350tn worth of financial products worldwide, either to trade directly, or influence how other securities are priced. 

The full legal process has, of course, yet to play out; no one has yet been charged. But as the probe gathers pace, it is already illustrating at least four key points. 

Firstly, and most obviously, the story shows that journalists – or any other outsider – should never give up trying to grope around in the murkier bits of finance; society desperately needs outsiders to peer into the financial weeds, asking naive questions, even – or especially – in the face of formidable, well-funded PR teams. 

Secondly, the pieces of finance which most badly need probing are probably not the most exciting or visible parts... 

But what actually sparked the great financial crisis in 2007 was not anything “sexy” – to use media slang – but “boring” triple A-rated mortgage securities traded by dull entities such as bank conduits. Similarly, those boring triple A securities are central to legal probes into what the banks did during that credit boom and bust. And what caused the recent UBS scandal was the equally grey world of exchange traded funds and back office settlement and collateralisation procedures. So too in the scandal at Société Générale. 

That highlights a third lesson: if a sector is being ignored, because it looks dull as ditchwater, that can create a fertile breeding ground for quasi-cartels, particularly away from public markets, say in the over-the-counter world. 

The key issue here is a culture of “clubbiness” and/or practices justified by “tradition”.... banks have been setting Libor according to daily estimates, not actual trades. But this tradition continued because almost nobody inside the system had any incentive to rock the boat; and few outside this clubby world cared.

Gillian highlights 3 different ways that opacity expresses itself in the financial system.

• She identified the Wall Street Opacity Protection Team who is only too happy to stonewall journalists questions.

• She identified the lack of visibility into what is happening.

• She identified how working together Wall Street slips opacity from which only it can benefit into the financial system.

The Libor investigation shows that opacity is not just confined to bank balance sheets and structured finance securities, but extends throughout the financial system.

The Libor investigation also shows that where ever there is opacity in the financial system, Wall Street just seems to be on the side that benefits from the lack of transparency.