When Libor Scandal Needs Explaining, Media Calls on Professor Michael Kraten
Dr. Michael L. Kraten, assistant professor of accountancy at Providence College, is in demand by the media this summer as an expert on the Libor banking scandal that is reverberating through international financial markets.
In recent weeks, Kraten has been interviewed by Bloomberg Businessweek and The Wall Street Journal’s MarketWatch.com; quoted in such publications as the Financial Times and The Economist; appeared on WPRI-TV in Rhode Island; and been invited to present his research at Maastricht University in the Netherlands.
“It’s been a blast, and a learning experience for me as well,” said Kraten.
Libor is the London InterBank Offered Rate — an interest rate used as a benchmark for banks all over the world. It is compiled daily by the British Bankers’ Association based on a poll that asks individual banks to estimate how much they would charge each other to borrow for different periods and in different currencies.
In 2008, Kraten and three colleagues published an academic paper, Libor Manipulation?, which showed that the process of self-reporting was flawed and could allow individual banks to manipulate the key global interest rate.
Their study did not receive much attention at the time. But now authorities around the globe — including the U.S. Justice Department — are investigating whether more than 10 banks reported false rates for profit and to deflect concerns about their well-being, especially prior to the financial meltdown of September 2008.
In June, Barclays was fined $450 million for rate-rigging from 2005-2009 and its chief executive officer resigned.
“I do think (Libor) had a very important role in the entire financial crisis because interest rates are everywhere, and variable rates in particular are everywhere,” said Kraten. “It literally affects everybody. If you go out and you buy a car and your loan is a variable rate loan, or your credit card interest rate varies, or you have a variable rate home mortgage, or any kind of loan directly or indirectly held by a bank, you were probably told at signup that your rate will vary based on market conditions.
“Do you know what ‘market conditions’ means? It’s been Libor all along. That’s the primary driver of all of these variable rates.”
“Hiding in plain sight”
Kraten and his colleagues decided to study Libor four years ago after an article in The Wall Street Journal suggested that quotes the banks were offering for Libor were different than expected based on other measurements. Kraten said two of his colleagues specialized in using statistical methods to detect price-fixing and realized the same procedure could be used to study Libor.
“If you think about interest rates as the price you pay to buy access to money, we knew it should be possible to use those price-fixing tools in theory to look at interest rates, particularly for rates like the Libor rate,” Kraten said. “We said, ‘Data is available.’ We used an economic model.”
The paper was first published in August 2008 on the Social Science Research Network (SSRN), a global Web site for academic researchers, where the original version remains online.
In 2010, after a peer review, Kraten presented the paper at an American Accounting Association conference. Earlier this year, eager to have their study seen in Britain, he and his colleagues published it in the Journal of Banking and Finance. That led to a mention in The Economist that was quoted during a debate in the British House of Commons, and finally to this month’s media attention.
City A.M., a business newspaper circulated in London, cited the Kraten study in an editorial that said the Libor problem had been “hiding in plain sight” all along.
One quote from Kraten, originally published in Bloomberg Businessweek, has been repeated in other publications, including L’Expansion, a monthly business magazine in France, and Linkiesta, an online newspaper in Italy.
In the quote, Kraten says: “You have 16 banks employing people who are eating at the same restaurants, drinking at the same pubs. They look at each other as competitors, but also as friends. It’s easy to believe that whether or not they’re explicitly talking to each other, they understand each other well and they’re implicitly colluding.”
No “smoke-filled rooms”
The Libor manipulation was very visible, Kraten said.
“If you cut through, and even push aside the very advanced and sometimes obscure statistical analyses, and just look at the quotes on a daily basis, and how they changed over time or never budged over time, you can tell that,” said Kraten. “Whether or not it was an absolute conspiracy … There were no smoke-filled rooms. But clearly the bids themselves, the way they were moving or not moving over time, did not reflect what the British Bankers’ Association said they should have.”
In a weekly blog that he writes with his wife, Maureen Kraten, Kraten said Libor manipulation could be prevented by independent audits of the reported rates. In mid-July, newspapers reported that Treasury Secretary Timothy Geithner made the same suggestion in a private letter to the Bank of England in 2008, when he was president of the Federal Reserve Bank of New York.
Kraten, whose research is in behavioral accounting, joined the PC faculty in September 2010. He teaches Accounting Policy, the final class that accountancy students take before they graduate.
“It’s the last chance you have to pull the students’ noses out of the textbooks and make sure they’re ready to start working in the real world,” Kraten said.
When he was revising Libor Manipulation? for its publication in January, Kraten was aided by an “Ethics Across the Accounting Curriculum” grant awarded to the PC Department of Accountancy last year by PricewaterhouseCoopers. Kraten noted that “research in the public interest” has been a focus of the accountancy department for several years.
“In order to be a great school of business in the Catholic-Dominican tradition, we need to be able to apply our research activities to real-world challenges that possess ethical implications,” said Kraten. “My Libor research activity is just one example of our endeavors."
— Vicki-Ann Downing
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