Limiting damage from the Libor scam

The LIbor manipulation scandal represents yet another black eye for the financial industry.The good news is that its direct impact on individual investors, except perhaps ultrahigh-net-worth individuals, is likely to be relatively minor.

That’s because the most significant impact of the manipulation would have occurred in the derivatives markets — an arena used mostly by institutional investors — where instruments often are priced in relation to Libor. According to estimates, the prices of some $800 trillion worth of financial instruments use Libor as a benchmark.

The bad news is that it comes on the heels of several other financial scandals. To name just a few, there have been the scandal at The Goldman Sachs Group Inc., where the company appeared to be taking advantage of some clients, the Madoff scandal, and the mortgage-backed-securities scandal that contributed to the housing bubble and the financial collapse of 2008. Investors cannot help but be shellshocked.

The London Interbank Offered Rate is supposed to represent the average rate at which a selected panel of banks can borrow from one another for various periods of up to a year. It was established 26 years ago, as the development of new instruments made the financial world more complex, to provide a uniform measure of short-term interest rates.

One place where individual investors might have been directly harmed or helped is in variable-rate mortgages. If Libor were manipulated to be higher than it should have been, individuals would have paid too much in interest for their mortgages for as long as the distortion lasted.

If, on the other hand, Libor were manipulated to be lower than it should have been, then a home buyer would have paid less interest than an honest market would have demanded.

Investors might have been harmed indirectly during the financial crisis if they bought the stocks of banks that sent false signals about their financial health by reporting low Libor rates. Investors almost certainly overpaid in that situation. However, given the turmoil in the financial markets at the time, and the suggestion that British regulatory authorities might have given signals about the manipulation that were, at least, mixed, damage could be difficult to prove.

Financial advisers have several responsibilities toward their clients as the Libor investigations continue.

The first is to examine the portfolios and mortgages of their clients to determine whether they suffered damage as a result of the manipulation and, if so, to join in efforts to recover any damages.

The second is to work to correct the impression that the financial services industry can no longer be trusted and that it is composed of unscrupulous individuals seeking to take advantage of the investing public. This could include joining industry initiatives to weed out bad actors in whatever segment of the financial sector they are found.

Third, financial services professionals must make their voices heard as new regulations are devised to fix Libor, or new benchmarks are developed to replace it.

It will take years, perhaps de- cades, to repair the reputation of the financial industry, but it can be done, and the repair work must begin now. The fact that heads have rolled at Barclays PLC is a good start.

It may convince other top industry executives that cheating does not pay, and encourage them to improve the controls at their firms so such behavior cannot go unchecked for so long.