The Shard: an apt visual metaphor for the Libor scandal. Photo: Getty Images

I stood outside the Shard yesterday and looked up. A giant phallic structure, gleaming with rain, as if still wet with spittle from The City’s latest skyward act of financial masturbation. It struck me that this was an apt visual metaphor of the public trying to understand the Libor Scandal – intimidated by its size and the mysteries of its structural complexities; feeling unable to criticise what they do not fully comprehend.

But, at its simplest level, the Shard is just a building. It has foundations like any other structure; it is made of the same materials; it obeys the same laws of physics.

I spent many years at the Office of Fair Trading, investigating cases of collusion and anti-competitive conduct not dissimilar to the Libor case. In my experience, whenever a party sat across a negotiating table and responded to an allegation with “the matter is very complicated”, it usually meant one thing. That the matter was very simple and the conduct utterly indefensible.

And it occurs to me that in an attempt to analyse the Libor Scandal we have become lost in its dark complex corridors and have failed to identify its biggest and most basic impact.

Libor (and its counterpart Euribor) are the starting points for setting the interest rate for, well, pretty much everything. To give you an idea of the size of the possible distortion, the FSA notes that the notional amount of financial instruments, derivatives and contracts which depend on Libor “in the first half of 2011 has been estimated at 554 trillion US dollars”. The World’s GDP for the same period was roughly 35 trillion US dollars. The manipulation of this interest rate by a tiny one-tenth of a percent can result in a distortion the size of the entire Eurozone rescue fund.

Here is a fallacy which has emerged over the last few days: there were winners and there were losers. When the rate was manipulated up borrowers lost out, but savers gained. When the rate was manipulated down, the converse happened. This is a perfect example of the simplistic masquerading as complex. It ignores the biggest and most dangerous impact.

Interest rates are all about the assessment of risk. The discovery that the basic Libor rate on which most such assessments are based was arrived at by collusion and was essentially fictional makes it unreliable. This creates extra risk. No prizes for guessing who will absorb this extra risk. Next time any lender sets its variable mortgage rate, they will be adding a little bit of fat, in case the Libor rate has been massaged down. Next time the decision is made on what interest to award to a pension fund, it will be made a little meaner, in case the Libor rate has been artificially boosted.

That is the real cost of the Libor Scandal. Rendering the Libor rate unreliable, is like removing the bottom block from an enormous financial Jenga tower. It is causing the entire construct to teeter and become more unstable at every level. Importantly, it makes it more susceptible to the next crisis. It may steady itself or it may collapse.

Against this urgent background, I watched our Prime Minister in the House of Commons this afternoon making party political capital by asking the Opposition to apologise for failing to regulate the Banks. It is worth reminding ourselves what the Conservative Party was advocating in 2007 – at the height of the Libor collusion:

“[Labour] claims that this regulation is all necessary. They seem to believe that without it banks could steal our money… This shows ignorance of how a competitive market works. Our aim is to liberate the economy from the burden of unnecessary regulations.”

It is also important to note what words of wisdom the IMF had to offer at the same time:

“The financial sector is strong and well supervised with a principle-based approach. The fiscal framework is good, and the mission focused on how to build fiscal cushions needed to respond to adverse shocks.”

It is vital to take this opportunity and change the culture in the finance sector at a fundamental level. It is a well established legal principle that there are two types of sanctions which have the capacity genuinely to change the behaviours of corporations. The first is a fine of a size which makes the infringement unprofitable. The second is legal action which pierces the corporate veil and apportions individual criminal responsibility….

New Statesman