The Libor Scandal: History's Largest Market Fraud?

While the Supreme Court’s health care decision and the 2012 election season have been dominating news in the U.S., in London a banking scandal is unfolding which threatens to engulf much of the British financial and political establishments. The story has barely registered in the U.S. outside of the financial press, but the scandal is set to spread across the Atlantic, and is being discussed as potentially the biggest market manipulation fraud in history.

Barclays bank has been fined $453 million by U.S. and UK regulators, and its American chief executive, Bob Diamond, has resigned after admitting its staff rigged the inter-bank “Libor” rate -- a daily measure of the interest rates at which banks lend to one another -- over a period of several years. The Libor rate affects interest rates paid to investors and by borrowers on mortgages and other loans. According to the Wall Street Journal, more than $800 trillion in securities and loans are linked to Libor.

This rigging was divided into two phases. Starting in 2005, Barclays traders conspired to manipulate Libor up or down for personal gain. This is bad enough, but it’s the second phase of the scandal that’s likely to have the greater ramifications. Around 2008, with the financial crisis in full swing, senior figures at Barclays ordered staff to distort Libor downward to create the impression that the bank’s finances were more sound than was the case. And Barclays bosses have claimed this manipulation had the tacit approval of the Bank of England -- the UK central bank -- and ministers in the then-Labour government, who wanted to shore up confidence in the economy. The current Conservative-led coalition government has gleefully launched a parliamentary inquiry into the affair.

Barclays’ involvement in the scandal emerged because they reached an agreement with regulators, admitting their guilt in return for reduced fines. Several banks are still under investigation, including UBS and Citigroup in the U.S. Lawsuits that could run into tens of billions of dollars are being prepared on behalf of individuals, companies, and institutions who have suffered losses.

At best, the scandal has revealed an appalling lack of bank regulation. At worst it suggests collusion at the highest levels between commercial banks, central bankers, and governments to manipulate interest rates for mutual benefit. It’s been suggested that the U.S. Federal Reserve could be dragged into the scandal.

This affair is set to run and run, and is likely to take all manner of twists in the coming months. But whatever the outcome, it’s clear there remain serious problems with the way big banks and financial institutions operate and are regulated. And conservatives shouldn’t be afraid to say so, because to acknowledge the problem is not remotely a concession that capitalism and free markets have failed.