Thursday, October 4, 2018
The Spider Network, by David Enrich
To provide a brief explanation, LIBOR is an acronym for the London Inter-Bank Offer Rate. This rate is supposed to represent the actual cost to London banks to borrow money from other institutions, providing an average institutional interest rate. By reflecting the rate at which banks can borrow money it in turn affects at which rate banks are able to loan money to ordinary consumers like you and me. This means that minor changes in LIBOR can have huge economic impacts. Among these economic effects are the trade in derivatives based on LIBOR.
Now this is where it starts to get complicated. Broadly speaking a derivative is a financial security whose value is derived from some sort of asset. This includes simple products such as stocks and bonds, but includes more complex instruments such as futures contracts, credit default swaps, and interest rate swaps. Among these instruments are derivatives whose value can increase or decrease based on whether the LIBOR goes up or down. As Enrich explains it in the book, these derivatives can be roughly explained as bets on whether LIBOR would go up or down. And based on the volume of trades in derivatives traders and brokers could make huge profits by even minor changes as little as a tenth of a percentage point.
Where this starts to get shady is how LIBOR gets determined. LIBOR is reported by the individual banks and there has been very little oversight of how LIBOR is set by the banks. This meant that as long as banks stayed within a certain band of expected values, banks could game the LIBOR system and push the overall rate in their favor. Enrich provides ample evidence that multiple bankers, brokers, and other organizations saw the manipulation of LIBOR for economic gain as a perfectly normal and acceptable practice.
If there's one thing I've taken from this book, it's that there is an underlying toxic culture within Wall Street and other financial institutions. It seems that booze-fueled benders and trips to strip clubs are par for the course among the biggest and baddest traders, not to mention blatant kickbacks and other free perks. In this cutthroat culture all that matters is who makes the most money, no matter how they make the money. It suggests that the culture among financial traders is in need of a massive reform and massive regulation.
I think this book is really interesting in how it illustrates the toxic culture of the financial sector and why people who are asked to do nothing but make money and are given little or no oversight will do plenty of questionable or downright illegal things just to get ahead. It makes a pretty strong argument in favor of a reform not only of the regulation of the industry, but also a reform of the dog-eat-dog culture as well.