Zachary Karabell on the Lessons of LIBOR Manipulation

by Reihan Salam

Zachary Karabell offers a helpful guide to understanding LIBOR manipulation:

What this scandal exposes is that governments, pensions, and people were so hungry to avoid the mismatch between what they intended to spend and what they could possibly take in that they started purchasing financial instruments that they never should have bought in the first place. It also exposes a much more uncomfortable fact of today’s global financial system: There is no such thing as a globally-set, fixed transparent cost of money. Interest rates are set by central banks on one hand and by myriad free-market forces on the other. There is no global mechanism or regulation that prevents banks from charging whatever rates they can, save for multiple sovereign laws on excessive rates and usury. In short, banks may have colluded to “game” the interbank rate, but given that that rate is itself a product of interbank voluntary reporting, there is no clear and evident rate that is then specifically gamed.

And in conclusion, Karabell argues that the broader public, municipal borrowers, and other market participants need to embrace the principle of caveat emptor:

Some have described the unfolding scandal as banks “tobacco moment,” drawing the analogy to the huge liability tobacco companies incurred for selling a deadly product and pretending it wasn’t. That may be an apt analogy, save for one vital lesson: in the end, reducing the deadliness of smoking wasn’t just about hobbling the tobacco companies; it was about people realizing that smoking is deadly. Many banks sell dangerous products to naïve customers. That will only truly end when those customers start making wiser choices.

I’m reminded of Hans Monderman, the legendary Dutch traffic engineer profiled in 2004 by Tom McNichol:

Monderman is one of the leaders of a new breed of traffic engineer – equal parts urban designer, social scientist, civil engineer, and psychologist. The approach is radically counterintuitive: Build roads that seem dangerous, and they’ll be safer.

And building roads that seem safe will make them more dangerous:

The common thread in the new approach to traffic engineering is a recognition that the way you build a road affects far more than the movement of vehicles. It determines how drivers behave on it, whether pedestrians feel safe to walk alongside it, what kinds of businesses and housing spring up along it. “A wide road with a lot of signs is telling a story,” Monderman says. “It’s saying, go ahead, don’t worry, go as fast as you want, there’s no need to pay attention to your surroundings. And that’s a very dangerous message.”

The same logic may well extend to other domains.