Confidential Study Reveals Global Finance Is One Big Guesstimate

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Former Barclays Chief Executive Bob Diamond leaves after giving evidence to the Treasury Select Committee at Portcullis House, central London Wednesday July 4, 2012. Diamond said Wednesday that his bank illegally reported low borrowing rates in October 2008 because other banks were reporting even lower ones, making Barclays look bad and threatening efforts to attract investment from Qatar. Pressure had been building on the bank over the past week since U.S. and British regulators imposed fines totaling $453 million against Barclays for false reporting of its borrowing costs between 2005 and 2009. (AP Photo/Lefteris Pitarakis)
Sadly it is probably too late for Diamond's "but all the other rate submitters are doing it!" defense. Photo: Lefteris Pitarakis

A few months ago, when the Libor-rigging scandal hit, casual finance-watchers were aghast at the idea that an interest rate that was used to set rates on trillions of dollars of mortgages, car loans, and other financial products was essentially calculated by polling a few banks and expecting them not to lie to everyone. The most important number in global finance run on the honor system? Couldn't be.

But it was, and Libor was in fact undone by its own trusting nature. As we now know, a coalition of overgrown frat boys conspired to rig the rate, jettisoning the gentleman's honor of Wall Street past and paving the way for Bob Diamond's ouster.

Surely, that was it, though, and replacing Libor with a transaction-based rate that took the prices of actual securities into account would solve the problem. There couldn't be more incredibly important financial numbers out there based on nothing more than a wink and a handshake, right?

Wrong, says Bloomberg, which obtained a confidential memo that revealed that Libor has lots of company when it comes to being easily manipulable:

Fewer than half of the benchmark interest rates surveyed in the U.S., Europe and Asia were based on actual transactions, according to a confidential International Organization of Securities Commissions discussion paper obtained by Bloomberg News. Instead, the rates were calculated by methodologies that were unclear, not transparent and only rarely subject to specific regulatory standards or obligations, the group said.

[...]

According to the discussion paper, about 80 percent of benchmarks were either compiled by associations or private entities. For survey-based benchmarks like Libor, the criteria for submitting data was not always objective and called for judgments about rates and prices, according to the discussion paper. Even in benchmarks that are based on actual transaction data, the compiling bodies retain discretion in producing the actual rates or prices.

Manipulation potential in 80 percent of the world's benchmark rates? That's a lot of Bollinger.