A Scandal far Worse than Subprime Mortgages - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 14 April 2012
A Scandal far Worse than Subprime Mortgages A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
Most of us know about the subprime mortgage scandal. In the years preceding the financial crisis, banks sold high interest rate mortgages to individuals who could never afford to repay those loans. Considerable profit was made by banks in the process, and it ultimately led to the financial crisis and global economic slowdown.

Recently, a new allegation of corrupt behavior at investment banks has emerged. It is regarding manipulation of the London Interbank Offered Rate (LIBOR). LIBOR is a daily interest rate that is meant to reflect the cost of borrowing for large banks between one another. It is also used heavily in derivative transactions, and many of the interest rates we see as consumers are indirectly influenced by LIBOR.

The derivative transactions that involve LIBOR are essentially securities that institutional investors can use to bet on which way LIBOR is going to go. The banks sell these securities to investors, and investors make a profit if LIBOR goes in their favor and a loss if it goes against them. A lot of the time, institutional investors use these derivatives to hedge against their own exposure to interest rates.

---------------------------- Yet Another Bailout... Speak out before it's too late! ---------------------------

When millions don't even have food to eat, our government is busy bailing out companies...

And this time, again, it's Air India.

This PSU gets a Rs 4,000 crore equity infusion... funded by the taxes we pay.

Not to mention the huge debt restructuring is basically a bailout in a different garb. And this runs into tens of thousands of crores.

Is this government really made up of our representatives or is it on the payroll of those corporate giants?

We at Equitymaster feel strongly about this cause, and thus have started an Urgent Poll where you can read all about this and cast your vote to make your voice be heard!

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The scandal that has emerged is that banks were colluding to set the LIBOR rates, and then selling derivative products to investors to bet on which way LIBOR would move. Since the contracts were between the bank and the investor, one party's loss was another party's gain. And so they convinced investors to bet on LIBOR moving in a certain direction, and then themselves set LIBOR rates to go in the other direction. As a result, banks made a large profit at the expense of the investors.

A good analogy to understand what is going on is to imagine that there is a cricket match between team A and team B. I am a bookie and convince you to bet on team A because I tell you that they are most likely to win. At the same time, I go and fix the match so that team B wins. In the end, I collect your money.

This is exactly what has occurred with the LIBOR scandal. Banks rigged the game so that only they could win. The LIBOR scandal has not been in the press as much as the subprime mortgage scandal mainly because it does not directly affect consumers or retail investors. But indirectly it does.

Many of the investors who lost out include pension funds and governments, whose losses will eventually become our losses. As of now, certain investment banks are under investigation as to the extent of their involvement in this scandal. Hopefully regulators will have the sense to inflict penalty in proportion to the crime, and prevent a reoccurrence.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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