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Libor Scandal The Latest Front In War On Reality

The Libor scandal looks and smells like an old-fashioned financial fraud, but it also presents the latest example of a more modern phenomenon: the war against reality being waged with ferocity by special interests that profit from limited public awareness of what's actually taking place.
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The Libor scandal looks and smells like an old-fashioned financial fraud, but it also presents the latest example of a more modern phenomenon: the war against reality being waged with ferocity by special interests that profit from limited public awareness of what's actually taking place. This campaign has proven remarkably effective -- not in altering reality, but in muddying perceptions, corrupting our basic understanding of matters both critical and mundane, from the risks of financial crisis or of climate change to our expanding waistlines.

For those who have grown too inured to financial shenanigans to bother keeping up, Libor is an interest rate that captures the costs that banks in London charge one another for short-term loans. Much of global finance is pegged to this rate, from ordinary mortgages to trillions of dollars' worth of credit derivatives, the exotic instruments that played a leading role in the financial crisis of 2008.

Libor plays such an outsized role in shaping the terms of global commerce that it is more than a benchmark. It is essentially a barometer for the health of the global financial system. People who manage money -- not just at investment banks, but at pension funds as well -- use Libor as a gauge of confidence. When Libor is seen to be low, this is taken as a sign that money is changing hands freely, without undue concern that borrowers will stumble or fail to pay back their loans. When Libor is rising, this is an indication that concerns are mounting, generating reluctance to lend money. In short, it is a signal to proceed with caution.

Executives of publicly traded banking behemoths are not fond of caution. They get rewarded for making their share prices climb, and that tends to happen when they expand what they do -- lending more money, making more trades, taking more risks. They get paid for saying yes to deals, and not for prudently saying no. Libor sometimes flashes the message that they ought to say no.

Barclays, the British banking giant at the center of the Libor scandal, doctored the numbers, hence the $450 million settlement it forged with regulators on both sides of the Atlantic. It reported that it could borrow more cheaply than it really could, bringing the Libor rate down. This seems to have accomplished two things: It made Barclays seem healthier than it really was, and it manipulated the values of derivatives that were tied to Libor, shifting the terms of these trades in Barclays' favor.

Think of the Libor shift as representative of something real and tangible, like a change in the weather. It was as if the bank was on the hook for insurance policies that would compensate farmers whose crops were damaged by torrential rains. Rather than pay up when the rains came, the bank instead issued bogus weather reports that showed an insignificant amount of rainfall. Those fake reports of better weather sowed false assurances among investors that there were fewer bad things to worry about: no threat that dikes that might not hold, less property damaged by floods.

In essence, the doctoring of the Libor numbers interfered with a crucial signal in the marketplace, squelching the warning sign that a transparent Libor reading might have delivered as financial institutions pursued increasingly reckless trading in the run-up to crisis. These effects are exceedingly hard to quantify, but it seems reasonable to assume that artificially low Libor readings emboldened ongoing risk-taking that made the resulting disaster worse -- a disaster whose costs are still being borne by ordinary people who lost jobs, homes and savings in multiple countries.

Barclays could not have pulled off this manipulation alone. We are still waiting to learn how broadly the con went. Word that Treasury Secretary Tim Geithner held meetings to discuss problems with Libor back when he was head of the New York Fed raises the disturbing possibility that a senior regulator tasked with keeping an eye on risk may have been effectively complicit in covering up the risk out of fear that the market could not handle any more ugly truth.

As last week ended, documents surfaced showing that Geithner wrote a memo to the Bank of England in the middle of 2008 detailing concerns about how Libor operated. But real events suggest that little to nothing came of those restrained warnings, and Geithner apparently let the matter drop. All of which seems consistent with a regulatory posture that sought to avoid freaking out the markets. As supposedly impregnable institutions like Bear Stearns and Lehman Brothers collapsed in 2008, the regulators seem to have decided not to make a fuss about the Libor massaging, with the thought that the markets might not endure any more disturbing spectacles.

This sort of calculation is increasingly operative beyond the realm of finance. "We can't handle the truth" -- this seems to be the mantra of many in the corporate sphere. When truth presents an impediment to profit, those who stand to profit often supply an alternate reality.

Consider the retail phenomenon known as vanity sizing. A couple of years ago, a blogger for Esquire trudged from store to store with a tape measure to investigate the actual waistlines of men's pants. At the Gap, pants labeled as having a 36-inch waist measured out to 39 inches. At Old Navy, 36-inch pants were really 41 inches!

The retailers had presumably figured out that confronting people with the discomfiting evidence of their swelling midsections was not a good way to move product, so they faked the numbers. Guys who might have gone into Old Navy and discovered that their protruding bellies were preventing them from fitting into the pants they wore in college might have fled home to dig out their running shoes while resolving to cool it with the pork rinds. Instead, Old Navy invited those same guys to feel wonderful about their physiques, wonderful enough to buy two pairs of comfy khakis and still make a stop at Cinnabon on the way home.

In an essential way, this is no different from what the banking crowd did in faking the Libor numbers. Reality delivered a signal -- we are too fat, the financial festivities are getting out of hand -- and the people in charge told reality to shut up and pass the nachos.

Masking reality is hardly a new business model, but the effects seem particularly pernicious in an age when so much marketing is applied to draping everything in a banner of healthy goodness. A recent New York Times investigation blew the cover off how huge agribusiness concerns like Coca Cola, Cargill and Kraft have come to dominate the standard-setting bodies that decide what officially constitutes organic. They have used that platform to change the definition in their favor, extending the imprimatur of wholesomeness to cheap, less-than-healthy ingredients. They are not merely cheating the customer by peddling chemicals as organic, they are warping our operative sense of what seems wholesome.

This is the modus operandi as well for climate change deniers who wield bogus "studies" -- typically financed by the petroleum industry -- that seem to undermine the scientific consensus that unrestrained reliance on fossil fuels puts humanity in grave danger. Rather than debate what we ought to do to adjust to this reality and transition to something sustainable, the denier lobby has attacked reality itself, along with the fundaments of science, polluting human understanding in the interest of keeping things lucrative for Exxon-Mobil.

And now here we are again, courtesy of the Libor scandal, absorbing another attack on reality.

Just as the largest financial institutions on earth were trading opaque instruments that ultimately brought the system to the edge of the abyss, delivering a crisis of joblessness from which we have yet to recover, the people in charge were intent on preventing the rest of us from getting an unobstructed look at the gauges -- a look that might have delivered more of a warning.