As any sporting bookie will tell you, you make more money by successfully betting against the favourite in a contest than you make betting for it. Doping the best horse to slow it down or bribing a cricketer to throw a match are tried and tested ways for your well connected crook to make a bundle. An innovation that was never going to go unnoticed by our financial innovators.
The FSA has suspected that some of our bankers have been doping the London Interbank Offered Rate (LIBOR), nudging it lower than it should be. LIBOR is an index generated by the British Bankers Association, and is supposed to show how much banks have to pay to borrow money from other banks (interbank lending). This is achieved by a panel of banks reporting how high an interest they believe (i.e. not based on what they actually have to pay (and why not, you may ask)) they would have to pay to borrow money.
Now, if this sounds like a 'pulling index' in which guys report how many drinks they have to buy to get a date that's because it is. The more unattractive the guy the more drinks he has to buy and ply. Naturally, most guys would under-report. Which is what the FSA has good reason to believe some bankers have done.
LIBOR is important for a number of reasons, including:
a) If a bank reports that it has to pay a higher interest rate to borrow that means it is "uglier", which in banking terms means riskier. The markets see this as a reason to have less confidence in the bank, which is reflected in the inevitable frowns and scowls next time it turns up wanting to do business.
b) LIBOR is used as a benchmark for some futures and options interest rate contracts. Traders and investors (including your pension fund) bet on the level of LIBOR. The rate going up or down decides who the winners and the losers are. As in any rigged market, the winners are the insiders.
Doping the LIBOR, making it lower than it should be, would create a great opportunity for those bankers who are into that kind of thing.
Consider a horse race. The favourite is running at, say, 1-5. The favourite is favourite because most punters are betting on it.
- If you bet £10 on the favourite and win, you get your £10 back plus another £2. A 20% gain.
- If you bet £2 against the favourite and win, you get your £2 back plus another £10. A 500% gain.
By manipulating the LIBOR, banks were able to 'dope' the favourite.
One group of punters who got on the wrong side of this rigged bet were small businesses. The FSA is investigating allegations that banks, including Barclays and Lloyds Banks, sold thousands of interest rate swaps to small businesses who wanted to put a cap on their interest rate costs.
These swaps are bets that meant if interest rates rose the businesses were protected. However, if they fell, then the businesses paid the banks. If a business wanted to get out of one of these swaps it could cost it hundreds of thousands of pounds. Enough to pay one banker his bonus; enough to put the business out of business. More details on this scam are available from Bully-Banks.