The Bank Bailout Story Behind the Libor Non-Scandal

There are countless reasons to decry bank bailouts, or the bailout of any business. To list but two, not only is it improper to force taxpayers to foot the bill for the mistakes of others, it's also the case that economic growth is cruelly restrained when bad commercial concepts are perpetuated such that always limited capital fails to reach innovative ones.

Unseen in the years since Democrats, Republicans and vain central bankers collectively lost their minds on the way to the subsidization of failure, is what we lost. Seen are the zombie banks and car companies who owe their existence to politicians who don't care about profits, but unseen are the companies never formed thanks to the consumption of capital on businesses the markets left for dead, and unseen is the much healthier banking system that would exist today had well run banks been allowed to swallow their failed competitors on the cheap.

Moving to the alleged Libor controversy, there's arguably a bailout story behind this latest non-scandal. But first, what's already well known should be mentioned; specifically that Libor is a series of interest rate benchmarks set by the presumed average cost of credit for 16-20 banks. As readers are aware, the banks that participate submit what they estimate to be their cost of credit, and the 4-5 highest and lowest estimates are thrown out.

Barclays, like many banks back in 2007-2008, was fearful about divulging its true cost of credit for fear of exposing itself as troubled. Banks need financing each day to fund their operations, their balance sheets serve as collateral for the credit attained, but with all banks at the time properly skeptical of others given broad knowledge that many financial institutions held questionable assets, there was perhaps a greater desire to be somewhat opaque.

Of course assuming Barclays truly lowballed the number in question, its false estimate wouldn't have factored into the calculation. And if it did, as in if Barclays' estimates actually worked to lower various Libor-informed interest rates, then the borrowers on whom lenders allegedly predate would have been made better off.

Back to banks more broadly in 2007-2008, it's fair to assume they were reluctant to reveal their cost of credit, but to the extent that Libor was compromised, would it really have mattered? Logic says no, and that's the case because no matter bank credit estimates, the markets clearly felt differently. We know this to be true given how many banks nearly went under thanks to an inability to achieve short-term financing due to collateral that was highly suspect.

Thinking about the above, this was a healthy thing. Those with credit on offer no longer believed in the balance sheets presented in order to attain it, the latter signaled a great deal of capital destruction on the way to ugly balance sheets, so the obvious result no matter Libor and other artificial rate benchmarks was that creditors were of the mind to raise the cost of finance as a way of preserving what was left.

Whatever Barclays' alleged false estimates, they obviously didn't matter much back in ‘08, and the information supporting this contention is once again all the banks that nearly went under. Rather than allow this healthy process whereby troubled banks would have been acquired on the cheap for their errors, the Fed and other central banks - really the only institutions with a true ability to manipulate credit costs - stepped in to artificially drive the cost of credit down in order to save many financial institutions that should have been allowed to fail. It's shooting fish in the proverbial barrel at this point, but for credit-distorting governments to express anger over private attempts to manipulate interest rates is for them to bring new meaning to the word "hypocrisy."

Of course, to even assume that all the non-scandalous Barclays' allegations are true is to miss the point. To understand why, readers should think back to the nightmare Goldman Sachs ran into after it was found that the investment bank pitted mortgage bear John Paulson against bullish clients in the now-infamous ABACUS deal. Once the non-scandal reached the news, many naively said Goldman had done its clients wrong by virtue of pitting them against a genius in Paulson. Of course, at the time of the deal, Paulson wasn't Paulson, everyone wanted to bet against him, and that's why he ultimately made so much money. Goldman paid the feds a fine, but as a Wall Street Journal editorial noted back then, the fine was merely payback for GS's backdoor bailout by the Fed in ‘08.

Readers should perhaps view Barclays in the same way. Though the British bank was nominally healthy amid the crisis, had a few financial institutions been properly allowed to fail, it's arguable that Barclays goes too. In short, the implicit bailout of Barclays back in '08 put British regulators in the position to have their way with the bank nearly four years later. Scandal no, but payback for an implicit bailout, yes.

The notion of "Too Big to Fail" continues to inform the economic/business discussion given the false view that banks are an essential form of finance. They're not, but if one believes they are, it's essential to cease all bailouts. The heavy fine paid by Barclays and the sacking of its top executives lends credence to this view because absent it being beholden to a British government that saved it not long ago, it doesn't cave like this.

Hapless governments bailed the banks out in order to slowly strangle them with fines and rules such that banking will cease being profitable and dynamic. As a result, talent will soon depart the banking sector, much as it left Detroit and the U.S. automobile sector beginning in the ‘70s. The bailouts foretold the injustice brought on Barclays, and the unfortunate next step is that increasingly talentless banks will need even more taxpayer support to prop up what governments are presently smothering.