Few people understand how one of the most important levers in a debt-laden economy – interest rates – are set. Many believe that the rate is simply a result of supply and demand – the supply of savings and demand for those savings. Not true. In fact in Anglo-American economies savings have precious little to do with it. Interest rates – those for short-term and long-term loans; safe loans or risky loans – are a social construct. They are decided by a committee of mostly men. In Britain, the official rate is set by the Bank of England’s Monetary Policy Committee. In the US the official rate is set by the Federal Reserve’s Open Market Committee.
But there is another, less transparent committee of men that set interest rates. They are members of the private British Banking Association, and they set a rate of interest known as the Libor rate …. as Bloomberg (27 May, 08) explains:
” Every morning the BBA, an unregulated trade group, asks member banks how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies from dollars to euros and yen. It then calculates averages, throwing out the four highest and lowest quotes, and publishes them at about 11:30 a.m. in London. Three-month dollar Libor was set at 2.64 percent today.”
Libor is an extremely important rate. It is the rate used to set millions of loans for companies, as well as for all the fancy debt products, leveraged private equity buy-out loans, derivatives etc. conjured up Finance’s alchemists these last few years. It is also the rate that determines the cost of repayment on millions of US household mortgages. Its impact, therefore is international. Most of the time the privatised Libor rate is closely aligned to official rates. This gives the official central bankers comfort – that they do after all, control all rates of interest. However, this summer Libor rose well above the official rate, because banks had lost confidence in what other banks were saying about the true state of their finances, and as a result charged each other more. This had costly implications for those debtors whose loans were based on Libor.
It also had implications for the official sector – the government/taxpayer-backed Central Banks, like the Fed BoE, and the European Central Bank. Their powerful governors, e.g. Ben Bernanke of the Fed. and Mervyn King of the BoE, lost control over a key lever of the economy – the rate of interest being charged for mortgages and loans. This in turn had political implications.
Because of the suffering, and the political impact in the US of the rising Libor rate, questions have been asked about the way in which this rate is socially constructed. The British Bankers Association says it simply relays what banks tell it they have been charged as a rate of interest. But Bloomberg smells a rat. They report that” UBS AG, which has taken $38 billion of writedowns and losses, replaced its chief executive officer and chairman and saw its stock tumble 60 percent…….Yet on 85 percent of the days between July and mid-April, the Zurich-based bank told the British Bankers’ Association that it could borrow in the money markets at lower interest rates than its rivals. Not even the U.K.’s Lloyds TSB Group Plc, which only wrote down $1.4 billion, could obtain the rates UBS said it was able to get, according to data compiled by Bloomberg.”
In other words, these bankers may have been fiibbing. And the implication is that the Libor rate should have been much higher. How would we know? The process is not regulated, and therefore not publicly accountable. But the crisis of confidence in this privately fixed process is real. Watch this space.