The Libor Scandal In Full Perspective
By Paul Craig Roberts
July 20, 2012
Clearing House" --
article about the Libor
coauthored with Nomi Prins, received much attention, with
Internet repostings, foreign translation, and video interviews.
To further clarify the situation, this article brings to the
forefront implications that might not be obvious to those
without insider experience and knowledge.
The price of Treasury bonds is supported by the Federal
Reserve’s large purchases. The Federal Reserve’s purchases are
often misread as demand arising from a “flight to quality” due
to concern about the EU sovereign debt problem and possible
failure of the euro.
Another rationale used to explain the demand for Treasuries
despite their negative yield is the “flight to safety.” A 2%
yield on a Treasury bond is less of a negative interest rate
than the yield of a few basis points on a bank CD, and the US
government, unlike banks, can use its central bank to print the
money to pay off its debts.
It is possible that some investors purchase Treasuries for these
reasons. However, the “safety” and “flight to quality”
explanations could not exist if interest rates were rising or
were expected to rise. The Federal Reserve prevents the rise in
interest rates and decline in bond prices, which normally result
from continually issuing new debt in enormous quantities at
negative interest rates, by announcing that it has a low
interest rate policy and will purchase bonds to keep bond prices
high. Without this Fed policy, there could be no flight to
safety or quality.
It is the prospect of ever lower interest rates that causes
investors to purchase bonds that do not pay a real rate of
interest. Bond purchasers make up for the negative interest rate
by the rise in price in the bonds caused by the next round of
low interest rates. As the Federal Reserve and the banks drive
down the interest rate, the issued bonds rise in value, and
their purchasers enjoy capital gains.
As the Federal Reserve and the Bank of England are themselves
fixing interest rates at historic lows in order to mask the
insolvency of their respective banking systems, they naturally
do not object that the banks themselves contribute to the
success of this policy by fixing the LIbor rate and by selling
massive amounts of interest rate swaps, a way of shorting
interest rates and driving them down or preventing them from
The lower is Libor, the higher is the price or evaluations of
floating-rate debt instruments, such as CDOs, and thus the
stronger the banks’ balance sheets appear.
Does this mean that the US and UK financial systems can only be
kept afloat by fraud that harms purchasers of interest rate
swaps, which include municipalities advised by sellers of
interest rate swaps, and those with saving accounts?
The answer is yes, but the Libor scandal is only a small part of
the interest rate rigging scandal. The Federal Reserve itself
has been rigging interest rates. How else could debt issued in
profusion be bearing negative interest rates?
As villainous as they might be, Barclays bank chief executive
Bob Diamond, Jamie Dimon of JP Morgan, and Lloyd Blankfein of
Goldman Sachs are not the main villains. The main villains are
former Treasury Secretary and Goldman Sachs chairman Robert
Rubin, who pushed Congress for the repeal of the Glass-Steagall
Act, and the sponsors of the Gramm-Leach-Bliley bill, which
repealed the Glass-Steagall Act. Glass-Steagall was put in place
in 1933 in order to prevent the kind of financial excesses that
produced the current ongoing financial crisis.
President Clinton’s Treasury Secretary, Robert Rubin, presented
the removal of all constraints on financial chicanery as
“financial modernization.” Taking restraints off of banks was
part of the hubristic response to “the end of history.”
Capitalism had won the struggle with socialism and communism.
Vindicated capitalism no longer needed its concessions to social
welfare and regulation that capitalism used in order to compete
The constraints on capitalism could now be thrown off, because
markets were self-regulating as Federal Reserve chairman Alan
Greenspan, among many, declared. It was financial
deregulation--the repeal of Glass-Steagall, the removal of
limits on debt leverage, the absence of regulation of OTC
derivatives, the removal of limits on speculative positions in
future markets--that caused the ongoing financial crisis. No
doubt but that JP Morgan, Goldman Sachs and others were after
maximum profits by hook or crook, but their opportunity came
from the neoconservative triumphalism of “democratic
capitalism’s” historical victory over alternative
The ongoing crisis cannot be addressed without restoring the
laws and regulations that were repealed and discarded. But
putting Humpty-Dumpty back together again is an enormous task
full of its own perils.
The financial concentration that deregulation fostered has left
us with broken financial institutions that are too big to fail.
To understand the fullness of the problem, consider the law
suits that are expected to be filed against the banks that fixed
the Libor rate by those who were harmed by the fraud. Some are
saying that as the fraud was known by the central banks and not
reported, that the Federal Reserve and the Bank of England
should be indicted for their participation in the fraud.
What follows is not an apology for fraud. It merely describes
consequences of holding those responsible accountable.
Imagine the Federal reserve called before Congress or the
Department of Justice to answer why it did not report on the
fraud perpetrated by private banks, fraud that was supporting
the Federal Reserve’s own rigging of interest rates (and the
same in the UK.)
The Federal reserve will reply: “So, you want us to let interest
rates go up? Are you prepared to come up with the money to bail
out the FDIC-insured depositors of JPMorganChase, Bank of
America, Citibank, Wells Fargo, etc.? Are you prepared for US
Treasury prices to collapse, wiping out bond funds and the
remaining wealth in the US and driving up interest rates, making
the interest rate on new federal debt necessary to finance the
huge budget deficits impossible to pay, and finishing off what
is left of the real estate market? Are you prepared to take
responsibility, you who deregulated the financial system, for
this economic armageddon?
Obviously, the politicians will say NO, continue with the fraud.
The harm to people from collapse far exceeds the harm in lost
interest from fixing the low interest rates in order to
forestall collapse. The Federal Reserve will say that we are
doing our best to create profits for the banks that will permit
us eventually to unwind the fraud and return to normal. Congress
will see no better alternative to this.
But the question remains: How long can the regime of negative
interest rates continue while debt explodes upward? Currently,
everyone in the US who counts and most who don’t have an
interest in holding off armageddon. No one wants to tip over the
boat. If the banks are sued for damages and lack the money to
pay, the Federal Reserve can create the money for the banks to
If the collapse of the system does not result from scandals, it
will come from outside. The dollar is the world reserve
currency. This means that the dollar’s exchange value is
boosted, despite the dismal economic outlook in the US, by the
fact that, as the currency for settling international accounts,
there is international demand for the dollar. Country A settles
its trade deficit with country B in dollars; country B settles
its account with country C in dollars; and so on throughout the
countries of the world.
For whatever the reason--perhaps to curtail their accumulation
of suspect dollars or to bring Washington’s power to an end--the
BRICS countries, Brazil, Russia, India, China, and South Africa,
are agreeing to settle their trade between themselves in their
own currencies, thus abandoning the use of the dollar.
According to reports, China and Japan have reached agreement to
settle their trade between themselves in their own currencies.
The moves away from the dollar as the currency of international
transactions means that the dollar’s exchange value will fall as
the demand for dollars falls. Whereas the Federal Reserve can
create dollars with which to purchase the Treasury’s debt, thus
preventing a fall in bond prices, the Federal Reserve cannot
prop up the dollar’s exchange value by creating more dollars
with which to purchase dollars. Dollars would have to be taken
off the foreign exchange market by purchasing them with other
currencies, but in order to have these currencies the US would
have to be running a trade surplus, not a long-term trade
In the short-run, the Federal Reserve could arrange currency
swap agreements in which foreign central banks swap their
currencies for dollars in order to supply the Federal Reserve
with currencies with which to soak up dollars. However, only a
limited number of swaps could be negotiated before foreign
central banks understood that the dollar’s fall in value was not
a temporary event that could be propped up with currency swaps.
As the value of the dollar will fall as countries move away from
its use as reserve currency, the values of dollar-denominated
assets also will fall. The Federal Reserve, even with full
cooperation from the banking system employing every fraud
technique known, cannot prevent interest rates from rising on
debt instruments denominated in a currency whose value is
Think about it this way. A person, fund, or institution owns
bonds or any debt instruments carrying a negative rate of
interest, but continues to hold the instruments because interest
rates, despite the increase in debt, are creeping down, raising
bond prices and producing capital gains in the bonds. What
happens when the exchange value of the currency in which the
debt instruments are denominated falls? Can the price of the
bond stay high even though the value of the currency in which
the bond is denominated falls?
The drop in the exchange value of the currency hits the bond
price in a second way. The price of imports rise, and this
pushes up prices. The inflation measures will show higher
inflation. How long will people hold debt instruments paying
negative interest rates as inflation rises? Perhaps there are
historical cases in which bond prices continue to rise
indefinitely (or even hold firm) as inflation rises, but I have
never heard of them.
As the Federal Reserve can create money, theoretically the
Federal Reserve’s prop-up schemes could continue until the
Federal Reserve owns all dollar-denominated financial assets. To
cover the holes in its own balance sheet, the Federal Reserve
could just print more money.
Some suspect that the Federal Reserve, in order to forestall a
declining dollar and thus declining prices of dollar-denominated
financial instruments, is behind the sales of naked shorts every
time demand for physical bullion drives up the price of gold and
silver. The short sales--paper sales--cancel the impact on price
of the increased demand for bullion.
Some also believe that they see the Federal Reserve’s hand in
the stock market. One day stocks fall 200 points. The next day
stocks rise 200 points. This up and down pattern has been
ongoing for a long time. One possible explanation is that as
wary investors sell their equity holdings, the Federal Reserve,
or the “plunge protection team,” steps in and buys.
Just as the “terrorist threat” was used to destroy the laws that
protect US civil liberty, the financial crisis has resulted in
the Federal Reserve moving far outside its charter and normal
To sum up, what has happened is that irresponsible and
thoughtless--in fact, ideological--deregulation of the financial
sector has caused a financial crisis that can only be managed by
fraud. Civil damages might be paid, but to halt the fraud itself
would mean the collapse of the financial system. Those in charge
of the system would prefer the collapse to come from outside,
such as from a collapse in the value of the dollar that could be
blamed on foreigners, because an outside cause gives them
something to blame other than themselves.
Craig Roberts was Assistant Secretary of the Treasury for
Economic Policy and associate editor of the Wall Street Journal.
He was columnist for Business Week, Scripps Howard News Service,
and Creators Syndicate. He has had many university appointments.
His internet columns have attracted a worldwide following.