> In 1986, at age 17, it hit the big time: Libor was taken in by the British Bankers Association, a trade group described later by The New York Times as a “club of gentlemen bankers.”
What are the chances that this "club of gentlemen bankers" always intended to manipulate Libor to some extent?
I know finance and banking is very complicated; maybe someone will come along who happens to have been a banker in London in 1986 and will set me straight. Otherwise I find it hard to limit my cynicism when enormous amounts of money are involved.
LIBOR grew out of the same ecosystem that created Eurodollars. Originally a Eurodollar was simply a dollar held in a non-US domiciled bank, in particular a bank outside of the Federal Reserve System. The story, at least partly true, is that the Soviet Union was making a ton of money selling oil. Thanks to OPEC, the market for oil is denominated in dollars. Soviet oil companies didn't mind the dollars, but they didn't want money in US banks, and so the Eurodollar was created. In the USD money market (the interbank lending market for terms < 12 months) the most riskfree rate is the Fed Funds rate -- that is the rate which banks lend to ach other within the Fed system. In the money market for USD, everything was quoted in terms of Fed Funds, e.g. Fed Funds + 50 etc. Banks with EuroDollar deposits couldn't partake in the Fed system, but they needed something similar, and so LIBOR was created.
Well, then it grew. US banks got involved in EuroDollars and foreign banks got US subsidiaries and everything kind of ballooned.
But the big change was the invention of interest rate swaps. Interest rate swaps create a linkage between the Money Market (terms < 12 months) and the Capital Market (terms > 12 months). There are a bunch of economic explanations as to why interest rate swaps exist and some of them have to be true, but they're irrelevant to the LIBOR story. A vanilla fixed-floating swap needs a floating rate, and that's LIBOR. A couple of trillion dollars (notional) worth of derivatives later, instead of simply being a pragmatic way to quote rates in the money market, it then drove P&L of derivatives desks.
I think everyone knew the potential for manipulation was always possible, but for a long time I think, until the tail started wagging the dog, it worked. But there's no going back now.
> Otherwise I find it hard to limit my cynicism when enormous amounts of money are involved.
You should always be cynical when large amounts of money are involved. It helps you avoid large losses.
Side note - one of the best questions to ask in any deal is “how are you making money on this”. If the other party doesn’t tell you, then they probably know something that they don’t want you to know. If you doesn’t get a straight answer, walk away [0].
[0] - I work in finance and never do business with someone who is not transparent about this. Been doing it a long time and it serves me well. I learned it from an old hand, and cringes the first few times he asked it. Then, I got the nerve to ask why he asked such a cringeworthy question. Glad I did!
Banks took both sides of LIBOR contracts. So it wasn't really about manipulation so much as just having a standard to follow. Do you read about clubs of Silicon Valley browser makers meeting up to come up with a new HTML standard and assume that this is some nefarious plot? I imagine your London banker counterpart does.
What are the chances that this "club of gentlemen bankers" always intended to manipulate Libor to some extent?
I know finance and banking is very complicated; maybe someone will come along who happens to have been a banker in London in 1986 and will set me straight. Otherwise I find it hard to limit my cynicism when enormous amounts of money are involved.