6 Ways Big Banks Screwed Grandma

July 28th, 2012

… in the Price-Fixing Scandal That’s Rocking the World: Grandma’s finances will almost certainly never recover from the LIBOR scandal. And, needless to say, she never asked for it – Published on AlterNet, by Alexander Arapoglou , Jerri-Lynn Scofield, July 26, 2012.

Every business day at 11am, London time, something critical to the world economy happens. Leading “reference banks” are asked what they believe borrowing rates to be. Based on what they say, LIBOR (London Interbank Offered Rate) is set for that day. Those rates then flow through to the broader economy. They determine how trillions of dollars of loans, mortgages and derivatives are priced … //

… Who lost out, big time, from fixing these rates? Grandma, that’s who! The multiyear pattern of setting LIBOR too low screwed her in six ways. Her finances will almost certainly never recover from the experience. And, needless to say, she never asked for it.

1. Lower LIBOR reduced rates of return on prudent investments:

  • Two general principles dictate investment patterns during a person’s lifetime. First, as a general rule, people borrow during household formation, save (or invest) as empty nesters, and then spend their savings and investment income during retirement, along with any pensions. Second, investment patterns also change throughout an individual’s lifetime. People invest more aggressively in shares of stock, for example, earlier in life, and then shift into less risky fixed income investments as they age.
  • When you’re young, you can afford to assume greater risk in order to chase potentially greater investment returns. But as you get older, preserving your capital becomes more important. Prudent investment advice therefore directs older people and retirees into retail bank certificates of deposit, which are priced based on LIBOR benchmarks. So are most money market funds. But following this conventional wisdom has proven to be a bust for Grandma. LIBOR manipulation caused her income to drop by as much as 2 percent.

2. Lower LIBOR squeezed pension yields:

  • Along with other retirees, Grandma has lost out when the pension she expected to receive ended up with lower returns. Her pension’s viability depends upon the yield of her pension fund’s investments. Lower LIBOR translates to lower rates of return on the floating rate bonds the pension funds hold.
  • With LIBOR manipulated downward, corporations benefit from being able to borrow at lower rates. But their benefit is retirees’ loss. Either Grandma’s pension benefits must be reduced or the pension plan, public or private, must come up with more money to replace the shortfall from inadequate investment returns. That money has to come from somewhere, perhaps as in the case of public pensions, from higher taxes, or layoffs of teachers, police and firefighters –or any combination of these.
  • So, in the case of pension investments, the net result of lower LIBOR is a significant wealth transfer – from Grandma, who loses when interest rates decline, to corporations and the banks who’ve benefited from lowering LIBOR.

3. Finagling LIBOR is securities fraud, which ultimately spanks bank profits and harms shareholders: … //

… 6. Lower LIBOR devastated state and municipal budgets:

  • The structured municipal bond market consists of borrowings by states, cities, hospitals, universities and other nonprofits. These complex financings combine a variable rate bond with an interest rate swap so that if all works as planned, borrowers end up with fixed rate financing, at a lower cost of borrowing.
  • If the variable rate on the swap is based on LIBOR, and LIBOR, is understated, the financing will fail to produce a fixed rate. The two parts of the financing won’t match properly. The borrower will still have to make payments on the bonds it has issued, but there will be a gap between the payments it must make, and the amount it receives from the swap.
  • It’s important to understand what these transactions are not: state and municipal authorities weren’t trying to make an arcane bet on the direction of interest rates. They were instead trying to buy insurance to protect against interest rate risk. They were told by the banks that sold them these instruments and those that provided them with financial advice that these financing structures were low-risk ways to reduce their borrowing costs. They were advised that this would be the most efficient way to achieve a fixed-rate financing for sewer systems, incinerators, hospitals, schools, transit systems, and other public works, and that they would be protected from interest rate fluctuations.
  • It’s not turned out that way. The extra money that went to banks that cooked LIBOR came at the expense of these public borrowers, who as a result of entering into such arrangements, face devastating financial consequences. These have led to huge budget shortfalls, which in turn, have caused these borrowers to slice spending, including pensions, school budgets, libraries, police and fire protection. Grandma and Grandpa have been unduly affected by these budget cuts, since the elderly rely especially on public services.
  • With interest rates at historic lows, why not simply refinance this municipal debt? Like Grandma, these borrowers have found they can’t easily exit these financing arrangements. Banks inserted draconian penalty clauses into the contracts that cover these transactions, and have refused to waive them to allow borrowers to renegotiate a better deal.

Conclusion:

  • Grandma lost out, big time. And the likelihood is that she’ll never recover her losses. No, it’s not a victimless crime. The banks screwed Grandma, and they’ll likely get away with it because too big to fail also means too big to nail, except for a slap on the wrist.

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