"We've lived through a period of mass financial delusion."
-- author Michael Lewis
For those who hoped the financial industry had put the era of short-term profits at the expense of the systems' stability behind it, this summer's LIBOR scandal is cause for pessimism.
LIBOR, the London Interbank Offered Rate, is the interest rate set nightly in England that underlies more than $350 trillion in assets globally. Those assets include adjustable-rate mortgages, credit cards and financial derivatives.
LIBOR was established about 25 years ago at the dawn of the age of financial derivatives to reduce friction in these new markets by creating common standards for what major banks estimated it should cost to lend money to each other the next day.
The system's accuracy was questioned in the years since the financial crisis of 2008, culminating in June of this year, when Barclays, the British-based global bank founded in 1690, pleaded guilty to manipulating the LIBOR standard, partially for trading speculation, partially to mask the increasingly high cost of its own borrowing from investors.
In a Sept. 28 column entitled "Taking the Lie out of LIBOR," the Economist describes the steps being recommended to reform LIBOR (www.economist.com/blogs/schumpeter/2012/09/interest-rates). They include making any manipulation of the LIBOR numbers a criminal offense and appointing an outside agency to crunch the numbers.
These solutions seem sound enough, but they are addressing the symptom, not the root cause. Why are we fooling ourselves with such greater frequency than our predecessors? Major financial emergencies are now erupting several times a decade, rather than once in a generation, as in the previous century. Shouldn't the Information Economy be smarter about bubbles? Yet events continue to demonstrate the need to adjust our financial system to the massive potential for fraud inherent in knowledge-based economies.