“According to news reports, UK banks fixed the London interbank borrowing rate (Libor) with the complicity of the Bank of England (UK central bank) at a low rate in order to obtain a cheap borrowing cost. The way this scandal is playing out is that the banks benefitted from borrowing at these low rates. Whereas this is true, it also strikes us as simplistic and as a diversion from the deeper, darker scandal.“
By Paul Craig Roberts and Nomi Prins
The following article is republished from www.paulcraigroberts.org here at LarsSchall.com with the personal permission to do so given by Paul Craig Roberts, who retains the copyright.
The Real Libor Scandal
by Paul Craig Roberts and Nomi Prins
According to news reports, UK banks fixed the London interbank borrowing rate (Libor) with the complicity of the Bank of England (UK central bank) at a low rate in order to obtain a cheap borrowing cost. The way this scandal is playing out is that the banks benefitted from borrowing at these low rates. Whereas this is true, it also strikes us as simplistic and as a diversion from the deeper, darker scandal.
Banks are not the only beneficiaries of lower Libor rates. Debtors (and investors) whose floating or variable rate loans are pegged in some way to Libor also benefit. One could argue that by fixing the rate low, the banks were cheating themselves out of interest income, because the effect of the low Libor rate is to lower the interest rate on customer loans, such as variable rate mortgages that banks possess in their portfolios. But the banks did not fix the Libor rate with their customers in mind. Instead, the fixed Libor rate enabled them to improve their balance sheets, as well as help to perpetuate the regime of low interest rates. The last thing the banks want is a rise in interest rates that would drive down the values of their holdings and reveal large losses masked by rigged interest rates.
Indicative of greater deceit and a larger scandal than simply borrowing from one another at lower rates, banks gained far more from the rise in the prices, or higher evaluations of floating rate financial instruments (such as CDOs), that resulted from lower Libor rates. As prices of debt instruments all tend to move in the same direction, and in the opposite direction from interest rates (low interest rates mean high bond prices, and vice versa), the effect of lower Libor rates is to prop up the prices of bonds, asset-backed financial instruments, and other “securities.” The end result is that the banks’ balance sheets look healthier than they really are.
On the losing side of the scandal are purchasers of interest rate swaps, savers who receive less interest on their accounts, and ultimately all bond holders when the bond bubble pops and prices collapse.
We think we can conclude that Libor rates were manipulated lower as a means to bolster the prices of bonds and asset-backed securities. In the UK, as in the US, the interest rate on government bonds is less than the rate of inflation. The UK inflation rate is about 2.8%, and the interest rate on 20-year government bonds is 2.5%. Also, in the UK, as in the US, the government debt to GDP ratio is rising. Currently the ratio in the UK is about double its average during the 1980-2011 period.
The question is, why do investors purchase long term bonds, which pay less than the rate of inflation, from governments whose debt is rising as a share of GDP? One might think that investors would understand that they are losing money and sell the bonds, thus lowering their price and raising the interest rate.
Why isn’t this happening?
PCR’s June 5 column, “Collapse at Hand,” explained that despite the negative interest rate, investors were making capital gains from their Treasury bond holdings, because the prices were rising as interest rates were pushed lower.
What was pushing the interest rates lower?
The answer is even clearer now. First, as PCR noted, Wall Street has been selling huge amounts of interest rate swaps, essentially a way of shorting interest rates and driving them down. Thus, causing bond prices to rise.
Secondly, fixing Libor at lower rates has the same effect. Lower UK interest rates on government bonds drive up their prices.
In other words, we would argue that the bailed-out banks in the US and UK are returning the favor that they received from the bailouts and from the Fed and Bank of England’s low rate policy by rigging government bond prices, thus propping up a government bond market that would otherwise, one would think, be driven down by the abundance of new debt and monetization of this debt, or some part of it.
How long can the government bond bubble be sustained? How negative can interest rates be driven?
Can a declining economy offset the impact on inflation of debt creation and its monetization, with the result that inflation falls to zero, thus making the low interest rates on government bonds positive?
According to his public statements, zero inflation is not the goal of the Federal Reserve chairman. He believes that some inflation is a spur to economic growth, and he has said that his target is 2% inflation. At current bond prices, that means a continuation of negative interest rates.
The latest news completes the picture of banks and central banks manipulating interest rates in order to prop up the prices of bonds and other debt instruments. We have learned that the Fed has been aware of Libor manipulation (and thus apparently supportive of it) since 2008. Thus, the circle of complicity is closed. The motives of the Fed, Bank of England, US and UK banks are aligned, their policies mutually reinforcing and beneficial. The Libor fixing is another indication of this collusion.
Unless bond prices can continue to rise as new debt is issued, the era of rigged bond prices might be drawing to an end. It would seem to be only a matter of time before the bond bubble bursts.
Copyright: Paul Craig Roberts
Paul Craig Roberts, an outstanding American economist, has had careers in scholarship and academia, journalism, public service, and business. Today he is chairman of The Institute for Political Economy ( www.paulcraigroberts.org).
Dr. Roberts was educated at the Georgia Institute of Technology (B.S.), the University of Virginia (Ph.D.), the University of California at Berkeley and Oxford University where he was a member of Merton College. He has been associate editor and columnist for The Wall Street Journal and columnist for Business Week and the Scripps Howard News Service. In 1992 he received the Warren Brookes Award for Excellence in Journalism. During his time of public service he was as an Assistant Secretary of the US Treasury in the early 1980’s. In January 1982 he resigned to become the first occupant of the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University. He held this position until 1993. He was a Distinguished Fellow at the Cato Institute from 1993 to 1996 and a Senior Research Fellow at the Hover Instition, Stanford University.
Dr. Roberts has testified before congressional committees on 30 occasions on issues of economic policy. He has contributed chapters to numerous books and has published many articles in journals of scholarship, including the Journal of Political Economy, Oxford Economic Papers, Journal of Law and Economics, Studies in Banking and Finance, Journal of Monetary Economics, Public Finance Quarterly. He has written or co-written eight books , among them: “How the Economy Was Lost: The War of the Worlds,“ published in January, 2010 by CounterPunch/AK Press. In 1984 he published the widely reviewed and favorably received book “The Supply-Side Revolution.“ He defined “Supply-side economics“ later this way:
“It says that fiscal policy works by changing relative prices and shifting the aggregate supply curve,not by raising or lowering disposable income and shifting the aggregate demand curve. Supply-side economics reconciled micro- and macroeconomics by making relative-price analysis the basis for macro-conclusions. The argument is straight forward: Relative prices govern people’s decisions about how they allocate their income between consumption and saving and how they allocate their time between work and leisure.“
In 1987 the French government recognized him as “the artisan of a renewal in economic science and policy after half a century of state interventionism” and inducted him into the Legion of Honor.
Chris Floyd, author of “Empire Burlesque,“ has written about him:
“I must say there are few people out there today speaking truth about power with the unblinking, unvarnished ferocity of Roberts. (And as I’ve noted here before, it is speaking truth about power — not the old cliché of ’speaking truth to power‘ — that we so desperately need. There’s no point in speaking truth to power — power already knows the truth of its monstrous crimes, and it doesn’t give a damn.) Time and again, I’ve started to write a post about some outrage only to find that Roberts has already been there, laying into the issue with a flaming brand.“
He is listed in Who’s Who in America and Who’s Who in the World.
Nomi Prins, who grew up in the US state of New York, worked after her studies in mathematics and statistics for Chase Manhattan, Bear Stearns in London and as a Managing Director at Goldman Sachs on Wall Street. After she left the financial industry, she became a prominent financial journalist who has written four books including the highly recommended: “It Takes a Pillage: Behind the Bailout, Bonuses, and Backroom Deals from Washington to Wall Street,” that was published in September 2009 by Wiley. Her most recent book, the historical novel “Black Tuesday,“ was published in late 2011 (and is also available for the Ipad). Furthermore, she is a Senior Fellow at “Demos” (http://www.demos-usa.org/) in New York City, gave numerous interviews to international outlets such as BBC World, BBC, Russia TV, CNN, CNBC, CSPAN and Fox, and her articles appear in The New York Times, Fortune, Newsweek, The Nation, The American Prospect and The Guardian in Britain. The website of Nomi Prins can be found at: http://www.nomiprins.com/. She lives in Los Angeles.
You may be interested also in this regarding Nomi Prins:
March 3rd, 2011
Author and journalist Nomi Prins (“It Takes a Pillage“) explains in an exclusive interview her view of the unrests in the Middle East, the causes for the rising oil price, and the big stories in the precious metal markets.
THE MATTERHORN INTERVIEW: “Market Manipulation and the Second Great Depression“
October 22nd, 2011
GoldSwitzerland has posted a new item, “Market Manipulation, Fraud, Corruption, and the Second Great Depression“ – an interview conducted by Lars Schall with financial journalist Nomi Prins from the United States and fund manager Wesley Legrand from Australia.
‘THE MATTERHORN INTERVIEW’ – October 2011
In an exclusive interview for Matterhorn Asset Management, Lars Schall discusses with financial journalist Nomi Prins from the United States and fund manager Wesley Legrand from Australia issues related to the precious metal markets, central bank policies, and the parallels between our days and the age of the Great Crash / Great Depression. Unfortunately, “we’ve just haven’t learned.“