Interest rates are the price for renting money. LIBOR rates is the price banks charge each other for renting money. Contrary to popular belief, the 2008 financial collapse was not initiated by mortgage derivatives, it was initiated by Repos, and their swaps. Repos (Repurchasing agreements between banks on short term lending between themselves) are specifically tied into the LIBOR rate. This is why the LIBOR scandal, which now includes the Royal Bank of Canada, is so important and sociologically interesting. If LIBOR was manipulated, then so were repos and swaps, which was the firing pin of the 2008 collapse. And there’s a strange Sociology to it, beyond banks acting badly to make a few (billion) bucks.
This is how repos, LIBOR and swaps work in a simplistic nutshell:
Basically, in this example, RBS makes a loan to both RBC and UBS. But it gives RBC favorable rates, while giving UBS not-so-favorable rates. RBC in turn swaps the UBS loan, pays off its RBS loan, and makes a half percent profit (rent). RBS gets both its 3% and 1% above LIBOR. And UBS gets a better rate (1.5%) than it would’ve otherwise gotten. Everyone wins on the swap – sort of. RBC and RBS make money, while UBS still has to pay rent on money, though at a lower rate.
Since UBS couldn’t change the swap rate, what if it could change the LIBOR rate so that mathematically, it ended up paying NO RENT on money? That’s exactly what UBS did. This is the LIBOR scandal in a nutshell. But it doesn’t end there. The Royal Bank of Canada did the same thing, to pay a lower rate on its repos, and instead of coming out .5% it came out ahead even more. And RBS did the same thing on its repos.
It’s not that banks were cheating the public – it’s all “commercial paper.” It’s that banks were cheating each other. In today’s neoliberalism, the penalties for cheating shareholders are far greater than if they just simply cheated the public. Which is why if the Royal Bank of Canada pays the 3x fines for it’s role in the LIBOR scandal, it would be bankrupt.
Canada has a similar program as the United States in the role of the FDIC. When a bank goes bankrupt, it’s taken into government receivership, and the “bad” parts” are stripped from the “good parts” to assure that depositors get their money back. The legal and philosophical question is: would, or should a government take a bank into receivership because of a foreign lawsuit? That’s the question that the Royal Bank of Canada’s part in LIBOR forces on the Political Economy front.
Here’s where the strange sociology comes in: not only did it take an institutional interaction for the LIBOR scandal to take place – multiple interactions between institutions, but it’s also something that banks have forced onto the general public – the United States from 2000-2008 and Canada today. Other than time and volume, there is little difference between repo swaps and debt consolidation.
Debt consolidation loans and balance transfer credit cards are similar to repo swaps, only on a longer term. If you have a stack of credit cards with balances (essentially, loans), then you can “swap” them out for one credit card at a lower interest rate. The same holds true for debt consolidation loans. Certainly banks encourage this. Banks get paid back at their original “rent” rate, and the consolidation bank get a cut. Meanwhile, you’re paying a lower interest rate than you otherwise would have. Except you cannot manipulate the “prime” interest rate.
What may work for institutions however, may not be in the best interest of everyday life. With Canadian household debt-to-income ratio now 165%, a majority of Canadians no longer believe that they will be debt-free in within 25 years. The same happened in the U.S.
Why doesn’t the Sociological Kool Aid of repo swaps work in the real world? That’s a complicated answer that involves income guarantees (or the lack thereof), institutions outliving people, to a few things in-between.
Mortgage derivatives came into play because when banks loan each other money in repos – even if it’s for overnight, they have to have collateral to back it up. Many banks used Mortgage Backed Securities from Bond markets, which were seen as “safe” assets for collateral. The problem was of course, that they weren’t. And when it was found out, banks stopped loaning each other money, which caused a run on investment banks, which…well, everyone knows the rest.
The original role of debt was to move capital (or income, or money) faster through the system that actually created wealth – albeit unequally. If you needed to buy a machine for $20,000 for your factory while you waited for your customers to pay $100,000, credit was helpful for the business enterprise. That machine created profit in the long run, and short-term debt facilitated that. Instead, through the practice of repo swaps (which started in the 1980s), where one debt is simply swapped for another, debt somehow managed to be considered wealth – and that message was passed along to the people through easy consumer credit.
The Sociological Kool Aid is that belief that debt is good, without actually saying that debt is good. Debit is (of course) NOT good. While consumption has been fueled by debt over the last 40 years, there is one economic social fact that is clear as day which came out of the 2008 crisis: debt never created wealth. Debt is not wealth. This social fact holds true across all people, all societies, and all institutions. Debt is not wealth whether you’re a bank, or a wage-worker.
Whether or not Canada’s central bank will step up to the plate to bail out the Royal Bank of Canada cheating shareholders – should it need to, is quite another sociological and economic quagmire.