Why The London Interest Rate Rigging Scandal Makes The Case For Reining In Banks’ Risky Trading

Both UK and US authorities are investigating several banks — most prominently Barclays — for rigging the London InterBank Offered Rate, a benchmark that governs interest rates on all sorts of financial products. According to a report today from Reuters, regulators knew as far back as 2007 that banks were manipulating LIBOR, but little was done to address the problem.

Banks were gaming LIBOR in order to profit off of its movements, and to make themselves look healthier during the financial crisis of 2008 than they actually were. “If attempts to manipulate LIBOR were successful — and the regulators think that Barclays did manage it, on occasion — then this would be the biggest securities fraud in history, affecting investors and borrowers around the world,” according to The Economist.

As CNN Money’s Stephen Gandel noted, the fact that banks were looking to profit off LIBOR’s movements shows the emphasis that they have put on trading over more traditional lending — and makes the case for rules that rein such risky trading in:

The real story, and the long-term concern for regulators, is not that lending rates were fixed, but how much of the business of big banks these days is driven by trading, not lending. Clearly, Barclays and other banks believed they could make more money on their trading desk manipulating the rate, then they would lose in their lending operations…All this appears to be more evidence for why we need a strong Volcker rule that separates lending from trading.

The $9 billion trading bust at JP Morgan Chase also shows the wisdom of restricting the ability of the biggest banks to engage in risky trades that are divorced from commercial banking practices. Instead, the Volcker Rule — the part of the Dodd-Frank financial reform law meant to address this problem — has been consistently watered down due to intense bank lobbying and compliant members of Congress.