Getting Out of Jail Free and the Ironies of Unintended Consequences

It works the same in the game of Monopoly and in the government’s monopoly over monetary policy and regulation.

On August 9th, Barclays agreed to pay $100 million to a number of U.S. states for the bank’s part in rigging LIBOR. As you remember, the London Interbank Offered Rate (“LIBOR”) is the rate at which the largest banks lend money to one another. The U.S. Justice Department recently indicted some LIBOR traders and intends to send them to jail. LIBOR is a big thing, as it helps set the price on trillions (yes trillions) of derivatives, mortgages, student loans, etc. It’s hard to tell how much LIBOR was manipulated, but estimates are a few basis points up or down on some days. Price fixing is bad; we can all agree.

It is ironic, then, that the U.S. government helped push LIBOR rates up more than 25bps over the past few months as a consequence of its effort to make the financial system safer via new money market regulation. Furthermore, it is hard to find any money market buyers who even wanted these reforms. These market reforms propose to make markets safer by taking away the institutional prime money market fund’s fixed dollar price and adding redemption gates and fees. These funds are massive—worth hundreds of billions—and will now need to buy less repo and commercial paper and more government securities to meet the new regulatory requirements that go into effect October 14th. 

The scramble to meet these new regulations is driving up LIBOR spreads, according to many market makers. To be fair, a small portion of the widening may be attributable to concerns over the creditworthiness of European banks, but this is not driving a doubling of spreads. As LIBOR approaches levels not seen since the European sovereign debt crisis, investors have to wonder if this too will play into the Fed’s decision-making process on monetary policy, as it has tightened financial conditions for banks that rely on this rate for funding. It remains to be seen if or when these rates will go down again. 

Three Month US LIBOR – Last Five Years

As we have been saying for some time, markets and security prices are increasingly being set by central banks and through regulation. We can’t control the rules of monopoly, but we can do our best to buy the right bonds at an opportune price. 

Source: Bloomberg, Financial Times, Barclays, Citi