The LIBOR
has, quite clearly, a substantial effect on the wider economy but why did banks
feel the need to fix it? This is of particular relevance as despite banks
quoting a particular price they easily could lend at a different rate yet
evidently they found it vital.
The period
of ‘irrational exuberance’ which led up to the current crisis saw the
beginnings of noticeable fixing of the LIBOR rate. Kregal, 2012, claims that
there were two stages to the fixing process; the first occurring in the midst
of the boom whilst the second began as a result of the bust. This analysis is
quite intriguing as it suggests that the initial phase was born out of greed
while in comparison the second was due to the breakdown of the short term money
markets. The LIBOR is inextricably linked to the US derivatives market acting
as a benchmark for transactions occurring within it. Therefore, if fixed it can make the manipulator a fortune. Snider and Youley, 2010,
find evidence to suggest that the structure of a bank’s portfolio, and in
particular its involvement with derivatives, impacted its calling of the
interest rate. What is particularly striking is that, as Choy, Shung, Chng,
2012 comment, in the US it is a federal offence to manipulate the derivatives
markets yet this did little to deter the interference.
In recent times, a more rational reason for fixing has evolved. The
fear of bank panics, heightened after the bank run on Northern Rock. The
subsequent failure of other banks which were often spouted to be as a direct result
of bank panics rather than problematic banks, instilled fear in many banks' management. Therefore it is not illogical for
banks to decide to portray their LIBOR as far lower than the actual cost at
which they were willing to lend. In fact, as Hortacsu, and Kastl, 2009, point
out, lending in the interbank market at the height of the crisis was minimal,
therefore, the LIBOR was realistically futile.
The phrase
financial liberalisation or deregulation has become synonymous with the Great
Crash. The LIBOR could be seen as the very characterisation of this policy. A
simple definition of the LIBOR may be termed as banks deciding the interest
rate at which to lend to other banks whilst being regulated by a bankers’
association. To those new to the concept, now that the era of deregulation is
behind us, this concept must appear strange. It illustrates the power banks had
at the beginning of the 21stcentury. This presents the questions; had
the crash not happened would it have been allowed to continue? Did banks fix
the rate because they knew they could?
