If you borrow money at an interest rate that is linked to something, then you have to understand the thing to which it is linked. If you were to borrow money linked to the base rate of a major bank (or one of the base rates of a major bank) you will know that the rate you pay will rise and fall. You rather put yourself into the hands of the bank and the market. If the bank’s base rate to which your interest rate is linked, is also a base rate that is used to attract deposits to the bank, then your interest will fluctuate more or less in line with the market.
At one time there was another safeguard; a central bank, such as the bank of England, would publish a base rate, to which other base rates would be linked. The central bank used the base rate as an instrument of government policy, in attempts to control inflation. The base rate would go up and down, and the interest paid by borrowers would go up and down, in attempts to punish borrowers if they pushed up inflation by demanding higher wages.
These days we have a free market which is free for the bankers but holds in chains the ordinary borrowers and depositors. Central bank base rates are unfashionable and it is left to the free market to offer base rates linked lending.
I suppose that is why the London Inter Bank Offered Rate (LIBOR) became more popular as a link to lending interest rates. It was supposed to be a rate calculated by reference to the rates that banks lent to each other in a reasonable market size at a particular time of day in a specific currency. Each of the contributor banks must submit a return of the costs of its funds in the interbank market and from these returns a formula is applied and the LIBOR rate is found.
After all the recent scandals with banks fiddling the LIBOR rate, sometimes to show that they were safer than they actually were, and other times in order to make more money by LIBOR manipulation that they would have made by submitting honest returns, you would have thought that the Augean stables would have been by now well and truly cleaned by regulators and prosecutors and borrowers and lenders would be able to trust LIBOR as being what it said on the tine – an average of rates at which banks lend to each other.
Alas, this does not seem to be the case. Gary Gensler, chairman of the US Commodity Futures Trading Commission (where they seem to do these things far better with stricter rules and tighter controls than we do in London) has warned that LIBOR is still not free of fraud and claims that it is often still completely invented.
It seems that the stables have only been lightly dusted and not deep cleaned. We need a Hercules to divert a river to flush out the years of accumulation of fraud, bad practice and mess. Only then can we be sure that LIBOR is what it says on the tine, rather than an adulterated version of it. Until then, perhaps heed Polonius and neither a borrower nor a lender be, and particularly do not a borrower be, because borrowing does more than dull the edge of husbandry in this present market, it makes husbandry impossible.
Filed under: climate change | Tagged: Augean Stables, banking, borrowing, business, economy, financial markets, Gary Gensler, inflation, interbank market, lending, LIBOR, london inter bank, London Inter Bank Offered Rate, Polonius, US Commodity Futures Trading Commission |