Sunday, September 23, 2012

LIBOR 3: The Good

Unintended consequences can be positive.

As mentioned in the first postings, LIBOR affects consumers in two ways.  On August 3, 2012, the WALL STREET JOURNAL in the Weekend Investor section ran an article entitled "What LIBOR Means for You."  It mentioned the same two ways noted in the first posting on LIBOR.  1) LIBOR estimates affect the cost of borrowing at variable rates.  If the estimates in LIBOR are too high, variable rates are above what the market would justify and borrowers are forced to pay rates that are artificially inflated.  If the estimates in LIBOR are too low, borrowers receive an artificially low rate.  2) LIBOR estimates also affect the returns on savings by reducing the return to lending.
Some consumers may have figured out that by reducing the interest earned on consumer and business loans, an artificially low LIBOR would affect the rate banks to pay on savings.  Some may even have realized that it affects the returns on bond funds.  The article is useful in that it goes beyond that obvious connection.  It points out how the role of LIBOR in pricing derivatives feeds through to the return on savings.  Most consumers are probably unaware of how derivatives affect the return on their bonds, mutual funds and even stock mutual funds.  Unfortunately, it doesn't cover it in detail.  There are, after all, many consumers who would benefit from explicit examples.

However, to continue with “The Good, the Bad, and the Ugly" theme introduced in the second posting on LIBOR, we need some good.  There is plenty of bad and the ugly in the silliness of the LIBOR scandal.  But the good, is more subtle.
There is, however, plenty of good coming out of the LIBOR scandal.  As might be expected, that good is creating some bad and ugly also.  However, first, let's focus just on the good.  On July 30, 2012, the WALL STREET JOURNAL reported on some of the lawsuits related to LIBOR.  The article entitled "New York Lender Files LIBOR Lawsuit" reports: 

In the latest sign of the potential legal vulnerability facing banks ensnared in the world-wide probe of interest-rate manipulation, a New York lender alleges in a lawsuit that it was cheated out of interest income because rates on loans tied to LIBOR were ‘artificially’ depressed.”
“The lawsuit effectively argues that the alleged manipulation short-changed lenders by helping borrowers pay less for mortgages and other loans.”

Without judging the merits of the lawsuit, it's clear that there is an inherent good in finding someone willing to stand up and protest the treatment of savers and investors.  It's also refreshing to see this ribald reenactment of the Christmas classic “It's a Beautiful Life” with a small bank taking on a large bank.  Perhaps the plaintiff will be able to muster the support George Bailey receives from the community.  But even if it is class-action lawyers playing vulture rather than Clarence the Angel, at least someone has taken the side of the small saver and investor.  It, also, doesn't hurt that it's an as politically connected a group as the class-action lawyers who are taking up the cause.
It's important to understand that it is the posture of protesting the shortchanging of savers that represents the good coming out of this.  The merits of the case are a totally separate issue.  A serious look at the actual case is likely to focus one's attention totally away from LIBOR.  The correct focus is taken in a September 16, 2012, WALL STREET JOURNAL opinion piece entitled "Bernanke and the FedRepeal Einstein."

Albert Einstein reportedly called compound interest ‘the most powerful force in the universe.’ He didn't live long enough to experience Ben Bernanke.”
“Last week the Federal Reserve chairman told the world that U.S. savers should expect the new normal of near-zero interest rates to last through mid-2015. So compound interest is a concept with which today's early to mid 20-somethings will remain essentially unfamiliar.”

Perhaps more people will come to realize that it is not banks that set interest rates.  It is the Fed.  If they do, it would serve us well because as the article goes on to state:
“Thrift—that is, work and delayed gratification—is both a personal and societal good. It is supposed to allow us to be self-sufficient in future years, support older generations now, and finance the great engine of progress that has been the American economy. But why save when common instruments such as savings accounts, money-market funds and CDs guarantee that you'll lose out to inflation?”

Courtesy of the Fed, we currently provide no incentive to save.  It is highly likely that it will have to be savers that force a change since the Fed is convinced that it can eliminate all incentive to save without detrimental effects on the economy.  It's a preposterous notion, but then the Fed seems totally oriented toward short run impacts.  That may or may not be advisable, but what is clear is that individuals are beginning to resent the Fed’s financial repression.  So, the LIBOR scandal may have resulted in an awkward way for people to express their resentment of the Fed policy, but at least it gives them a vehicle by which to express it.  That's the good from the LIBOR scandal.


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