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Libor And The Corruption Of Creditism

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Barclays Bank was forced to pay a “fine” of US$453 million earlier this month in a case related to the manipulation of the London Interbank Offered Rate (Libor), one of the most important benchmark interest rates in the world. It now looks as if a number of other large banks will eventually be implicated along side Barclays. To me, this scandal, in and of itself, is not as important as what it exposes about the nature of the banking industry, as well as that industry’s grip on political power within our society.

Let’s begin with the basics. Whoever creates the wealth controls the political power. Before the industrial revolution in the late 1700s, almost all the wealth in the world was derived from agriculture. Thus, the landed aristocracy controlled all the political power. That economic system was Feudalism. Once the industrial revolution began, most of the world’s wealth was derived from manufacturing. Consequently, during most of the 19th Century, the “captains of industry”, or “Robber Barons” if you prefer, held control of the political power. Then, during most of the 20th Century, giant industrial corporations did. That stage of economic development can be described as Industrial Capitalism.

In recent decades a new kind of economic system has taken shape. After the United States stopped backing money with gold in 1968, credit exploded. Total credit in the US expanded fiftyfold from $1 trillion to $50 trillion in only 43 years. During those decades, most of the world’s wealth was not derived from agriculture or manufacturing, it was derived from credit creation. Consequently, those who create the credit now control the political power. Those people are the bankers. I call this new economic system Creditism.

Banks create wealth by creating credit. (And, of course, credit and debt are two sides of the same coin.) As the explosion of credit creation gained momentum in the 1970s and 1980s, the banks became much more profitable and therefore much more politically powerful as a result of their “contributions” to political parties (to both the Republican Party and the Democrat Party in the US and to both the Conservative Party and the Labor Party in the UK) as well as to individual politicians.

By the end of the 1990s, the banking industry was unstoppable. In 1999, the Gramm-Leach-Bliley Act repealed Glass-Steagall and, in 2000, the Commodity Futures Modernization Act deregulated derivatives. Glass-Steagall was enacted in the early 1930s after the credit bubble of the 1920s imploded and caused the Great Depression. Its purpose was to separate commercial (i.e. deposit taking) banks from investment banks to prevent speculation by investment bankers from destroying the deposits of everyone else. It worked very well until it was repealed in 1999 as the result of lobbying by the banking industry.

Not content to stop there, the banks next pushed through the even more audacious Commodity Futures Modernization Act, which effectively removed the regulations that, up until then, had governed the use and trading of derivatives. Afterwards, most derivatives went largely unregulated. And, roughly 90% of all derivatives now trade in the Over-The-Counter (OTC) market, where there is practically no transparency, instead of through regulated exchanges which allow much greater visibility as to who is doing what and why.

During this phase of Creditism, 1990 to 2007, things began to become surreal. The banks began creating wealth not only by creating credit but also by creating derivatives. Between 1990 and 2007, the total value of all outstanding derivatives contracts rose from roughly $10 trillion (an already astronomically large number) to $700 trillion. To put the latter figure in context, $700 trillion is the equivalent to $100,000 per person on Earth and the equivalent to the value of everything produced on earth during the last twenty years (global GDP since 1992). The dDerivatives contracts change hands at the rate of $4 trillion per day – and that is only for the 10% that trade through exchanges. No one can say how much is the average daily turnover of the other 90% that trade OTC, but a good guess would be A Whole Lot.

Derivatives became the raw material used by a sub-branch of the banking industry, the “Structured Finance” business. STRUCTURED FINANCE? It even sounds suspicious. What does that mean? Why would anyone structure his or her finances? It’s rather unclear. What is undeniablye clear, however, is that almost every major accounting scandal since 1990 has involved the culprits using derivatives to structure their finances in some illegal way; and there is a long list of such cases. I dare not name names. Google it for yourself: “Accounting Scandals” + “Derivatives”, then hit Search.

And that brings us back to Barclays. The bank was accused of submitting false information to the British Bankers Association about the interest rate at which it could borrow money from other banks. That information is compiled with thate interest rates from 17 other banks to determine a daily average. That average sets the Libor rate, which is the benchmark rate against which most conventional loans and untold (literally untold) quantities of derivatives are priced. The press has reported that Barclays falsified its submissions for two purposes. The first was to make it appear that it could borrow more cheaply than it actually could during the crisis of 2008, so that it would not seem in danger of collapse. The second reason according to press reports was to manipulate the Libor rate in a way that would allow traders employed by Barclays to earn more profits from their trading positions.

I do not know the truth of these allegations. However, the payment of a $453 million fine suggests that something was amiss somewhere.

None of this should come as a surprise to anyone. Most human beings are driven by the need and the desire to make money. And, unfortunately, history suffers no shortage of examples of the bad things – sometimes truly terrible things – many people will do to make money if society does not make and enforce laws that prohibit them from doing so. When such laws do not exist or are not enforced, no one should be surprised when bad things do happen.

In other words, there is no point blaming a dog for knocking over and going through all the trash cans in the neighborhood. It’s in the dog’s nature to behave that way. Either the dog must be chained up or the lids on the trash cans must be tightly sealed. Otherwise there will be a big mess.

As citizens of a democratic society, it is our responsibility to chain up the dogs (in every industry) and to seal the lids. Because iIn recent years a lot of dogs have slipped their leashes due to excessive deregulation. This is going to require more than the re-imposition of sensible financial sector regulations. It’s going to require campaign finance reform as well. Until banks and other corporations are prevented from making unlimited campaign contributions, it is unrealistic to expect our elected officials to bite the hand that feeds them.

Creditism is far less stable thant either Feudalism or Industrial Capitalism. In fact, it is now in danger of collapse because credit cannot continue expanding since the private sector cannot bear any more debt. In this twilight of Creditism, it is not surprising that the banks are being driven to increasingly desperate measures in order to continue generating “wealth”. That is because when they cease to generate most of the wealth, they will lose their grip on political power. And, as is well understood, when ruling classes fall, they often suffer reprisals.

Original publish date: July 16, 2012

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