The LIBOR affair
How Britain’s rate-fixing scandal might spread—and what to do about it
Jul 7th 2012


SINCE we have not more power of knowing the future than any other men, we have made many mistakes (who has not during the past five years?), but our mistakes have been errors of judgment and not of principle.” So reflected J.P. Morgan junior in 1933, in the middle of a financial crisis.

Today’s bankers can draw no such comfort from their behaviour. The attempts to rig LIBOR (the London inter-bank offered rate), a benchmark interest rate, not only betray a culture of casual dishonesty; they set the stage for lawsuits and more regulation right the way round the globe. This could well be global finance’stobacco moment”.

.The dangers of this are obvious. Popular fury and class- action suits are seldom a good starting point for new rules. Yet despite the risks of banker-bashing, a clean-up is in order, for the banking industry’s credibility is shot, and without trust neither the business nor the clients it serves can prosper.

At present, the scandal rages in one country and around one bank. Barclays has been fined $450m by American and British regulators for its attempts to manipulate LIBOR. The bank’s first attempt to ride out the storm failed miserably; Bob Diamond, Barclays’ chief executive, resigned this week. The British government has ordered a parliamentary review into its banks. The reputation of the City of London, where LIBOR is set by collating estimates of their own borrowing costs from a panel of banks, has been further dented.


But this story stretches far beyond Britain. Barclays is the first bank in the spotlight because it offered to co-operate fully with regulators. It will not be the last. Investigations into the fixing of LIBOR and other rates are also under way in America, Canada and the EU. Between them, these probes cover many of the biggest names in finance: the likes of Citigroup, JPMorgan Chase, UBS, Deutsche Bank and HSBC. Employees, from New York to Tokyo, are implicated.

The bank and the Bank

The evidence that has emerged from the Barclays investigation reveals two types of bad behaviour. The first was designed to manipulate LIBOR to bolster traders’ profits. Barclays traders pushed their own money-market desks to doctor submissions for LIBOR (and for EURIBOR, a euro-based interest rate put together in Brussels).

They were also colluding with counterparts at other banks, making and receiving requests to pass on to their respective submitters. A similar picture of widespread collusion emerges from documents related to the Canadian investigation. This bit of the LIBOR scandal looks less like rogue trading, more like a cartel.

That could end up costing the banks a lot of money. LIBOR is used to set an estimated $800 trillion-worth of financial instruments, affecting the price of everything from simple mortgages to interest-rate derivatives. If attempts to manipulate LIBOR were successful—and the regulators think that Barclays did manage it, on occasionthen this would be the biggest securities fraud in history, affecting investors and borrowers around the world. That opens the door to litigation not just by the direct customers of implicated banks, but by anyone with a financial interest in LIBOR. The lawsuits have already begun.

The second type of LIBOR-rigging, which started in 2007 with the onset of the credit crunch, could also lead to litigation, but is ethically more complicated, because there was a “public good” of sorts involved. During the crisis, a high LIBOR submission was widely seen as a sign of financial weakness. Barclays lowered its submissions so that it could drop back into the pack of panel banks; it has released evidence that can be interpreted as an implicit nod from the Bank of England (and Whitehall mandarins) to do so. The central bank denies this, but at the time governments were rightly desperate to bolster confidence in banks and keep credit flowing. The suspicion is that at least some banks were submitting low LIBOR estimates with tacit permission from their regulators.

When trust is bust

The story will probably now shift to civil courts around the world: that could be a long process. From a public-interest perspective, two tasks lie ahead. The first is to find out exactly what happened and to punish those involved. Where the only motive was greed, the individuals directly involved in fraud should face jail. If the rate was lowered to keep the bank afloat, and regulators were involved, both the bankers and their rule-setters should explain why they took it upon themselves to endanger the City’s reputation in this way. In Britain an independent inquiry makes sense—the speedier the better, which argues for the parliamentary sort the government wants rather than the judicial variety the opposition demands.

The second task is to change the way finance is run—and the culture of banking. This after all is not the first price-fixing scandal: Wall Street has had several. A witch hunt would be disastrous, but culture flows from structure. The case for splitting retail and investment banks on “moral grounds is weak, but individual banks could do more: drawing fines from the bonus pool is one example. And some rules must change. LIBOR is set under the aegis not of the regulator but of a trade body, the British Bankers’ Association. That may have worked in the gentlemanly days when “the governor’s eyebrows” were enough to keep bankers in order. These days the City is the world’s biggest centre of international finance.

-In future, LIBOR and its equivalents like EURIBOR should be set on the basis of actual, not estimated, borrowing costs. That is not always possible in finance: when markets are illiquid or thinly traded, hypothetical numbers may be needed to produce a benchmark. More banks should therefore be required to join the panel of submitting lenders, so that it is less easily gamed. Data should be cross-checked wherever possible, by asking banks what they would charge to lend as well as what it costs them to borrow. And the whole process should be intrusively monitored by an outside regulator.

“The banker must at all times conduct himself so as to justify the confidence of his clients in him,” said J.P. Morgan junior. That trust has been forfeited: it must be regained.

July 4, 2012 7:50 pm

Enough is enough of the age of consumption

Until fairly recently economists envisaged three stages of economic development.

First, there was the stage of capital accumulation started by the industrial revolution. The Marxist historian Eric Hobsbawm called it the age of capital. Society saved a large part of its income to invest in capital equipment. The world gradually filled up with capital goods.

This stage, economists thought, would be followed by the age of consumption, in which people began realising the fruits of their previous frugality. They would save less and consume more, as the returns to new investment fell and the possibilities of consumption expanded.

Then would come the third and final stage, the age of abundance. With a surfeit of consumption goods, people would start swapping greater consumption for greater leisure. The world of work would recede. This was supposed to be the end point of the economic phase of history.

Much of the world has not yet reached the age of consumption. The Chinese, for example, still save and invest on a colossal scale. Our problem is that western societies remain stuck in the age of consumption. We are much, much richer than we were 100 years ago, but hours of work have not fallen nearly as much as productivity has risen, and we go on consuming more than ever. We seem unable to sayenough is enough”. Why not?

One starting point to answering this question might be Keynes’ futuristic essay Economic Possibilities for our Grandchildren, published in 1930. In this essay he predicted that by now we would only need to work 15 hours a week “to satisfy the old Adam in us”. The rest would be leisure time. What did he get wrong?

We can concede straight away that the earlier economists, taking their cue from the privations around them, suffered from a certain poverty of imagination. They thought in terms of quantities: you can eat only so much food, have so many pairs of shoes, live in so many houses, drive so many cars. They failed to allow for continued improvement in the quality of goods, which stimulates the appetite for serial consumption, and so keeps up the hours of work.

But we must not concede too much under this head. Many improvements are negligible and, even when positive, consumers are constantly seduced by advertisers into over-estimating their benefits – as with the wonderful effects of all those innovative financial products.

A more serious charge is that many of the older generation of economists underestimated insatiability. Having more seems to make us want more, or different. This is partly because we are by nature restless and easily bored. But it is mainly because wants are relative, not absolute: the grass is always greener on the other side. The richer we become, the more we feel our relative poverty.

There is a third factor, however, for which the earlier economists can’t really be blamed. They were not egalitarians, but they did think that growing prosperity would lift up all boats. They did not foresee that the rich would race ahead of everyone else, capturing most of the fruits of increased productivity. (Karl Marx is the main exception here.)

The result has been to leave big holes in our consumption society. A lot of people still do not have enough for a good life. In Britain, 13m households, 21 per cent of the total, live below the official poverty line. There is a lot of underconsumption going on relative to what society is producing. Earlier socialists called itpoverty in the midst of plenty”.

This partly explains the huge rise in debt, as people aim to compensate for stagnating incomes by borrowing.

So what is to be done? First, we must convince ourselves that there is something called the good life, and that money is simply a means to it. To say that my purpose in life is to make more and more money is as insane as saying my purpose in eating is to get fatter and fatter. But second, there are measures we can take collectively to nudge us off the consumption treadmill.

One is to improve job security. Government should restore the full employment guarantee. This does not mean guaranteeing everyone a 40-hour a week job. Government should gradually reduce the maximum allowable hours of work for most occupations, guaranteeing a job for everyone who wants to work that amount of time.

At the same time it should institute an unconditional basic income for all citizens. This would aim to improve the choice between work and leisure. Critics say this would be a disincentive to work. That is precisely its merit in a society which should be working less and enjoying life more.

Third, government should reduce the pressure to consume by curbs on advertising. We already have curbs to guard against specific harms: it would not be a big jump to recognise that excessive consumption is itself harmful – to the environment, to contentment, to any mature conception of the good life.

Underpinning these measures would be a steeply progressive consumption tax, with a top bracket of, say, 75 per cent. This would be a tax on what is spent, not on earnings. It would reduce the pressure to consume, finance basic income, and encourage private saving for old age and infirmity.

All these proposals are open to criticism. However, unless we take a collective decision to get off the consumption treadmill we will never get to the point of sayingenough is enough”. And if we don’t do that, we will go on wondering what all that extra money was for.

The writers’ latest book is ‘How Much is Enough? The Love of Money and the Case for the Good Life’

Copyright The Financial Times Limited 2012.

An Exclusive Interview with Eric Sprott from Sprott Asset Management. In this very personal interview, which took place on June 26, 2012, Eric reveals a profound look at what is happening currently to the world financial markets, the banking system and precious metals prices.

Eric Sprott

Eric Sprott is recognized as one of the world's premiere gold and silver investors, and as an expert in the precious metals industry.

He is Chairman of Sprott Money Ltd., and CEO, CIO and Senior Portfolio Manager of Sprott Asset Management LP, and Chairman of Sprott Inc..

Eric has been stunningly accurate in his predictions about the economy, including foreseeing the current financial crisis. He chronicled the dangers of excessive leverage, as well as the bubbles created by the Fed, while correctly forecasting the collapse of the housing and financial markets in 2008.

Eric's predictions on the state of the North American financial markets have been captured in articles he authored, titled "Markets At A Glance".


Eric has more than 40 years of experience in the investment industry. After earning his chartered accountant desi, Eric entered the investment industry as a research analyst at Merrill Lynch and Company Inc. In 1981, he founded Sprott Securities (now called Cormark Securities Inc.), which today is one of Canada's largest independently owned institutional brokerage firms. After establishing Sprott Asset Management LP. in December 2001 as a separate entity, Eric divested his entire ownership of Sprott Securities to its employees.

Eric's investment abilities are well represented in his management track record of the Sprott Hedge Fund LP, Sprott Hedge Fund LP II, Sprott Bull/Bear RSP Fund, Sprott Offshore Funds, Sprott Canadian Equity Fund, Sprott Energy Fund and Sprott Managed Accounts.

PM: Eric, let's get right into this interview. Can you shed some light into the developments in Europe recently as it relates to Greece, Spain, Portugal, and some of the other weaker peripheral economies? What is the future of the euro currency in the present structure moving forward and how could this affect the future of the US dollar in the world economy?

Eric: That is a big question, Patrick, but let me try to answer it in many ways. I have always believed that one of the world's fundamental flaws is the leverage in the bank system. As you might be aware, the typical leverage of a European bank is something like 30 to 1. This means you have roughly 3 cents of capital supporting $1 dollar of assets, and as these economies have run into a bit of a roadblock (the best examples are Greece and Spain), you find out that values were too high.

So housing prices go down, mortgage values go down, the values of businesses go down, and people start putting two and two together, and they realize that the bank has a problem. So as we witnessed here in the last number of months, people in both Greece and Spain have taken large amounts of deposits out of those banking systems. If you just imagine being levered 30 to 1 and then the depositors take money out, theoretically, you have to sell one of those assets that is depreciated. By selling an asset that is depreciated, the impact on your capital can be very serious, if you're losing 20 and 30 and 40 cents on the dollar of the asset you're selling.

We have had and seen very many data points of the amounts of money going out of Greek banks. As the money has gone out, the sovereigns are working with the banking system and realize the fragility of that system. Those sovereigns tend to try to bail out the banking system. So we see that Greece was supporting the banking system, and as people realized that the liabilities of the banking system are now being transferred to the sovereign, which is exactly what's happening. Then the rate of interest that the sovereign has to pay starts shooting up because you are taking on all those liabilities.

Greece's rates shot through the roof. Spain after the bailout, their rates shot up because the existing holders of bonds realized they are taking on more and more liabilities. Then the likelihood of me getting my bond repaid is diminishing over time. So this is an ongoing process that was started with the financial meltdown. Really, I guess it hit a high point when Lehman failed.

The one thing that the central planners figured out after Lehman is you can't allow an insolvency where people have to sell their assets. So post-Lehman, pretty well anyone who was in the situation where they might fail was taken over.

We could use the example of Fannie Mae, Freddie Mac, CitiGroup, GM, JP Morgan, AIG, all the loans to the various banks, and the UK taking over Northern Rock and Spain taking over Bankia. The reason they do this is because if you didn't fund them, you would then have a liquidation where someone had to sell something. Of course, when you have to sell something, it's worth a lot less than when you choose to sell something. We get the real value of those bank assets in more of a liquidation selloff mode. In which case, that capital of the banking system would disappear so fast, as we found out through the experience of Unicredit. They did a rights issue; they were the only bank who ever tried to do a rights issue. Of course, it was a disaster because I think their market cap went down by more than the money they raised.

We've never had a bank try to raise capital since, because the markets are aware of the banking system's problems. The minute the market is aware, your stock goes down in value.

PM: Especially when the currency is not backed by any type of collateral, it's pure paper.

Eric: Totally,then more and more. It used to feel strange to use the word Ponzi, perhaps 5 or 10 years ago. But it certainly does not seem strange today to use the word Ponzi, because solutions to these problems seem to come out of nowhere.

I think of the Spanish bank bailout -- they put a 100 billion Euros in and everyone says we have a solution. Of course, they never said where the 100 billion Euros is coming from, just that we have a solution. No one figured out where the money's coming from yet.

All these proposals are made, but where's the money coming from and who's going to buy all these Euro bonds if someone is going to come in and suggest to buy them? Who is going to front the money? And getting the money to be actually put up is a lot different than just talking about it. So it's very Ponzish in my mind.

PM: Moving into that direction, Eric, we know the US budget deficit is running at record levels, and there are no signs of any political resolution to reduce its magnitude. So what is the risk and liability of principal loss in, for example, the twist operation bond purchases by the Federal Reserve if interest rates do begin to rise, and how would this impact the price of gold and silver in the US economy?

Eric: Right, I think there are many parts to that question. I wrote an article about two years ago, and it was called "Surreality Check, Dead Governments Walking."

It is a very simple analysis to do on the US government. Just use the US government statistics -- for example, you know they have approximately $16 trillion of known outstanding debt.

Every year, the Department of the Treasury publishes a number that shows the unfunded present value of the obligations, such as this Social Security plan that has nothing in it.

It also includes Medicare and Medicaid, civil service pension plans, and things like that. Those are in the area of $74 trillion dollars. So we are looking at a country that has $90 trillion in obligations present value, which goes up by about $5 trillion in a year, if not more. That has a GDP of $15 trillion, with a GDP, if I measure it with deficit losses, of $1.5 trillion a year. It is supposed to take care of $90 trillion in obligations. So I'm more worried about the principal repayment, rather than the cost of the interest.

To your point, if the US government had to pay 6 percent instead of 2 percent across the board, you'd have another $640 billion of interest obligations per year on the outstanding debt. That would take the deficit up to $2 trillion dollars.

I think the key thing that people should be aware of is that most of these countries have hit what is called the "Minsky moment." The definition of the Minsky moment is causing your economy to grow by borrowing excessively year after year.

There is a time when the productive engine can't take care of all the debt. Greece is the best example of the productive engine. Their GDP can't possibly pay back the $450 billion. So somebody took a $100 million dollar write off and I would say the same is probably true of the US.

We have this $15 trillion dollar GDP, which has combined $90 trillion in obligations. There's just no way that by running an annual deficit you could ever imagine that they will be available to fulfill those obligations.

It's not just the US. It's Japan, the UK, Spain. They are all in the same situation, where we have allowed this expansion of debt to go on for a long time, and now we have realized we can't pay. Thank God interest rates are next to nothing. What if interest rates went back to normal? We all know interest rates are manipulated by the central planners. The next thing you know, we going to have zero interest policies. Well that's fine for you to say, but why would people willingly buy bonds where, in essence, they lose money every year to inflation. It just doesn't make sense.

PM: So what is the probability that gold would become an integral part of the negotiations, as a way to provide some kind of guarantee or collateral against any additional financial stimuli, or prevent the risk of global contagion or, potentially, a world depression?

Eric: You hear more and more about gold coming in to the discussion, particularly as it pertains to Europe.

There was a paper recently that said that each government should take care of 60 percent of their GDP -- whatever amount of debt that is -- and then the difference would be put into an omnibus thing that all the European governments would be responsible for. But the countries would have to pledge their gold. It makes the statement to me that gold is a better asset than any other asset in the world.

We've also seen -- I actually think it was in the US -- where they are trying to redefine what sort of AAA assets are in the banking system. They start with cash, and the next is gold.

You don't have to put up any collateral or capital in the bank calculations if you have gold. So, you can see gold moving into a position where it's certainly considered a better asset than cash or bonds or things like that.

In fact, probably one of the best references is Bill Gross, who writes a letter every month. In his June letter, he basically suggested that, while bonds aren't providing that great a yield, maybe people should be thinking of buying real assets like gold.

It seemed odd, the bond king saying "buy gold." But you know, it makes all the sense in the world. More and more, I see gold coming to the forefront as the true stability of value.

PM: What role does China have in the world economy, especially with respect to the yuan, which could potentially replace the dollar as the world reserve currency?

Eric: Well that you mention China is interesting. They have become a huge importer of gold recently. I don't know if you have seen the data in the last 10 months, but their gold imports from Hong Kong into China have gone up about 600 percent. That is a huge number, and I think in the month of May, it's something like a 103 tons. While we only mine less than 200 tons a month, China is now importing a 100 tons. That's up from about 10 or 15 tons for the same time last year.

I think the non-G6 countries have thought the G6 has gone over the top with their unlimited swap lines and their LTRO's and their Quantitative easing. They think, I don't want to have anything to do with the G6. I'd much rather own something physical. So you see this move happening in Russia, China, Kazakhstan, the Philippines and the various other non-G6 countries, which are all stepping up to gold purchases.

PM: You mentioned Russia, but we don't hear much about Russia. How do they potentially fit into the equation as it pertains to gold and oil?

Eric: The one thing we know about Russia is they almost could have been the most consistent buyer of gold in terms of adding it to their reserves. China and Russia don't export any gold, so I think it's when you read some of the comments of either the politicians or the central bankers over there.
I think they realize what's going on in the G6 and recognize they are way better off just keeping gold instead of taking one of the G6 foreign currencies. It's a much better investment.

Back to your original question about the yuan becoming the reserve currency. I think whoever wants to be the reserve currency had better have a lot of gold backing it up, because faith in currencies must be declining at almost as rapid a rate. We just see the foolishness going on and the irresponsibly.

PM: Is this a concerted effort maybe for a world devaluation of paper currency as a measure to possibly reduce the burden of global record debt levels?

Eric: I don't know if I would put it that way yet, Patrick. I think it's a concerted effort not to let the existing systems fail. That is what the effort is like -- don't let anybody go down and let the first domino go. Whatever we do, we must keep that from happening.

The way I look at it, when you have that much, there is only one way of solving a huge debt problem. You either repudiate the debt, or you make it less valuable. In other words, you end up with hyperinflation of some sort, which allows you pay off the debt with depreciated values.

That could also go back to gold or, all of a sudden, the countries that have gold might say, why don't we revalue gold to $10,000 an ounce? Now we can all say, we can back our currency. That might ultimately happen. Maybe it won't happen, because they said something, maybe it will happen, because everyone realizes that currency is being devalued and the price of gold does go to $10,000 and starts to back the currencies.

PM: When you look at the sentiment, Eric, particularly for the shares, the gold, silver mining shares. These stocks, they have gotten clobbered, and I think in terms of measuring the sentiment it's been the worst, I read somewhere, in 100 years.

Eric: Yeah, it probably has. But you know it's interesting, I see some things change.

First of all, the stocks are up 20 percent off their lows, if you look at the HUI index.

Two, I see people changing their views on gold. I have already mentioned Bill Gross, who seems to be changing his view.

There was a pension plan in Japan that announced it was going to put one 1.5 percent of its money into gold. Pension plans putting their money into gold -- that's almost unheard of. But I can honestly see why it would happen in Japan, and I'm shocked it took 25 years to figure it out. But their markets have gone down for 25 years. They made no progress in the stock market for 25 years. They have no yield on their bonds. Why wouldn't they think of putting some money into gold?

One other factor I've seen recently is that, within our portfolios, we've had about six or seven takeover bids of our small companies, including Exstory, Yamona, just two days ago. I am gold bid for Trelawney.

We had a company called Silvermex taken away. We also had a company called Norton Goldfields, which was in Australia, being taken over by a Chinese mining company.

So we've seen a lot of action. Even the average person wouldn't see there all small acquisitions. It's the stocks and, by the way, they pay big premiums. I think the premium on Exstory was something like 68 percent. So the market can evaluate action, but the buyer valued at 1.68 times thinks he's getting a deal. So if we get enough of these intermediate and senior companies coming into the arena, I think it will change people's views in very, very short order.

The biggest thing for gold stocks, of course, is the price of gold. Unfortunately, the paper global markets are way bigger than the physical gold markets. The same with silver, and for a short time, the guys in the paper market can have their day because they trade in billions and billions of dollars of gold in the paper market. Even though there's not that much produced every day, and they tend to determine the price, they're doing it based on charts and things like that.

I just look at the physical demand, and I can tell you, the physical demand for gold has never been stronger than it is today.