The Libor scandal has taken over the headlines recently and is said to be the biggest fraud in history. The LIBOR is the interest rate used by banks to lend to each other. Not only is it used for inter-bank lending, it is also used as an underlying rate for derivatives and as a benchmark for just about every type of loan someone can get. It has been estimated that the Libor rate is used as an index for upwards of $350 Trillion dollars in loans.
Bankers are being investigated for fraudulently influencing interest rates in their favor to look as if their balance sheets were healthier than they in fact were, and in order to generate profits from interest rate spreads with their unique investments while leaving average consumers to flip the bill. There’s discussion of producing criminal lawsuits against the perpetrating organizations and regulators and politicians will be reviewing exactly what they should do that will call for accountability.
There is an incentive to ensure that there are safeguards in place so that this doesn’t happen again and to fine those banks that have taken part in any possible fraud, but the governments around the world are unlikely to go as far putting something in place that would destroy or drastically change the banking sector itself. Putting in regulations that might harm the banks could further deteriorate an already fragile economy. The banks implicated in the fraud are the very same banks that in the past have been labeled as “too big to fail” so it is unlikely that those institutions won’t continue to be defined as critical components of the fabric of the economy.
So what could all of this mean to investors? In general, we believe that it is time to keep an eye on the banking sector. There will almost certainly be lawsuits against the banks, and possibly a wave of new regulations. Anytime there are lawsuits or significant regulatory changes, investors establish a viewpoint and trade based on those beliefs. It is at that point in time that markets can become inefficient, and rather than trading on fundamentals, they trade on irrational market psychology.
There’s no going around the point that the banking field is very important to each element of the financial system. Whether it be financing to purchase an automobile, getting an education loan or perhaps home loan, or possibly a small business going to the bank in order to fund its ongoing work and pay its workers. Financial institutions are definitely an integral part of all of those things that is necessary for all of them to function properly. While acknowledging that we expect to see some volatility within the banking industry, it will in the end emerge from this particular scandal with a much stronger situation in the long term.
The positioning from a value investor standpoint would be to assess the health of banks, and note those that have a relatively strong balance sheet. It is likely that some of those banks will begin trading at discounted prices. The best investments may come from banks that were not named in the Libor scandal but are oversold for the mere fact that they are banks.
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