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Why a London banking scandal matters in Philly

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"Open Secret: The Global Banking Conspiracy That Swindled Investors Out of Billions" by Erin Arvedlund.

An international banking scandal centered in London might seem remote from readers in metropolitan Philadelphia.

But Philadelphia author Erin Arvedlund explains the connection while chronicling the Libor scandal that became known to the general public seven years ago.

Arvedlund covers personal finance for The Inquirer. Her books, however, transcend both personal finance and Philadelphia. Previously, she published Too Good to Be True: The Rise and Fall of Bernie Madoff. Madoff robbed mostly wealthy investors who trusted him. His schemes were difficult to unravel, but relatively easy to understand, thanks to a knowledgeable guide such as Arvedlund.

Warning: The outrage of Libor (an acronym for London interbank offered rate) is much more difficult to understand than the Madoff outrage. That is not a criticism of Arvedlund's reporting and writing. She is masterful at using plain language whenever possible to explain arcane concepts and specific arcane transactions.

However, when writing about Libor, huge dollops of jargon are unavoidable. So, potential readers, you must prepare to read many passages twice (or more) to figure out who was doing what to whom. The mess crosses international borders, involves multiple banks and government bodies, and lacks an obvious central character such as Madoff. Rather, in her helpful "cast of characters" at the front of the book, Arvedlund lists 54 individuals.

Libor began about four decades ago as a convenience for banks and major borrowers needing to track variable interest rates at any given hour. Banks reported their lending rates to a central place, and the compiler of those rates performed the calculations, then made the numerical figure known to those who cared. Arvedlund's mission in the book is to explain how the numerical figure became "a vehicle for outright theft" in Great Britain, the United States, and other nations, through "widespread - and illegal - manipulation."

Spoiler alert: Although regulatory and supervisory government agencies around the world have acknowledged the illegalities and some firms have paid billions in fines, no individuals have been imprisoned or received meaningful punishment for their roles in the scandal. That might happen during 2015 or later, Arvedlund notes, but my reading suggests the system is so profoundly broken that the criminals will escape without imprisonment and in some fashion continue the manipulation of Libor. (I hope I am mistaken.)

So, what does all this matter to individual Philadelphians, and others of modest income across the United States? It turns out, Arvedlund explains, that home mortgages, student loans, and credit card interest rates are pegged in part to the Libor number. The massive manipulation of the Libor rate to profit bankers might steal money from struggling individuals thousands of miles away.

In terms of Philadelphia's municipal finances and school district finances, Arvedlund explains how huge Wall Street banks such as Citigroup and J.P Morgan promoted transactions involving Libor. She asks a central question: Why did the relatively unsophisticated financial officials in City Hall and school district headquarters become involved? What were they "thinking when they allowed Wall Street to sell them these complicated side bets on interest rates?"

To seek answers that general readers might grasp, Arvedlund offers an example of "the thought process in Philadelphia." In that example, the decision makers include Rob Dubow, Philadelphia's finance director, and Nancy Winkler, Philadelphia's treasurer.

"Like any other municipal borrower," Arvedlund writes, "Philadelphia issues bonds, and usually pays a fixed interest rate on them. Instead of just sticking with a plain-vanilla loan, officials such as Dubow and Winkler decided it would be a good idea to make a side bet on interest rates, entering into a swap with a bank. The city would then pay a floating (presumably decreasing) rate in exchange for a fixed rate from a bank, which would then take the opposite side of the bet, namely that rates would go up. Much as a homeowner would pay a fee to change his or her fixed monthly payment to an adjustable rate mortgage payment, so would the city. Except instead of just one fee, the city had to pay every month. The swaps were supposed to give the city lower borrowing costs in the near term, plus protection from rising interest rates longer term."

That did not always happen, and the worldwide financial crash gaining steam starting in 2008 made lots of deals look unwise. The swap losses tied at times to Libor might have cost Philadelphia as much as $500 million. That number alone could help area resident understand what Arvedlund is demonstrating in her book.


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Published by , 09.11.2014 at 17:27
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Rick Westly
Rick Westly 10 November 14 20:31 Philadelphia was sold another fraudulent financial product by Mercer Consultants when it signed on for the DROP payroll plan. Additionally, today, 20% of American homes hold mortgages worth more than the value of the house, all fraud perpetrated against the American public in the form of simple mortgages without any derivative to buy into on their end. Over and over again, the banks are found to knowing commit fraud, in addition to other clear cut crimes, such as money laundering for the Mexican drug cartels, only to be slapped on the writs with fines that on nowhere near severe enough to deter the fraudulent activities. Until we start prosecuting people at the banks, from the top down and sending them to jail for decades at a time, we can expect more fraud and eventually another financial collapse like the one 6 years ago. We are due for another soon. Text hided expand
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Anthony
Anthony 10 November 14 20:32 Blame the city's finance director for straying from the "plain vanilla" munis, not the banks. If the city enters a swap, they know they are adding additional risk for a potential reward, of lower rates in this case. Shame on them for trying to squeeze a few basis points out of the system with risky swaps when rates are at historic lows. As warren buffet puts it, derivatives are financial weapons of mass destruction. Dubow and the rest of those clowns are the ones that should be going to jail. Text hided expand
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