Foreign Affairs has one of the clearest articles I’ve read yet on the Libor scandal, written by Jonathan Macey (“Libor: Three Scandals in One“). I don’t have the knowledge on the minutiae of the modern banking industry to really know better, but some details of the press coverage — including Macey’s piece — don’t seem to fit together. It’s probably the skeptic in me, although I suppose it’s also out of ignorance: I don’t know all the details, neither do these journalists, and so much of it is still left to be uncovered.

Macey, although he isn’t the only one, suggests basing the rates banks place on loans to their clients on U.S. Treasuries. He notes that this was more-or-less the norm, until the Libor rates began to diverge from that of Treasuries; since then, banks have preferred to base their loan rates of Libor. Like I’ve tried to emphasize thus far, the specific details of price setting are currently beyond me, but there must be a reason why banks — seemingly in unison — have preferred the Libor over others. Knowing this much, why assume that basing loan rates on Treasury rates would be a good alternative to Libor?

There are differences in the essence of Treasuries and Libor. Treasuries are an asset, meaning that banks that hold these are earning interest on them (at very low interest, but at least an asset that is virtually guaranteed to be stable in value); in comparison, Libor is the rate at which banks expect to be able to borrow funds from each other. That is, if a bank were short of liquidity, it could borrow funds at a cost that should be roughly similar to Libor. Libor also reflects a rate that has more to do with the loans market than Treasuries do. One thing that follows is that commercial loans aren’t as low risk as Treasuries, so why would one lend at a rate that doesn’t cover the risk?

I don’t intend to deny that banks, such as Barclays, have committed fraud by reporting false borrowing rates to regulators (and, in this case, I think the best course of action is punitively fining these banks an amount greater than whatever benefits fraud can bestow). But, blaming everything a bank does on nefarious intentions seems like the easy way out of explaining the process as it actually works. It’s also an easy way of leading yourself to give bad policy advice.

This post has turned out to be more argumentative than I originally planned for or wanted. It has turned into a very cumbersome posing of what is a simple question: what’s actually going on here?