The LIBOR scandal: What it is and why you should care

July 25, 2012

The London Interbank Offer Rate, commonly known as LIBOR, was manipulated by Barclays and that should make you angry. Most people have no idea what LIBOR is, but it has a major impact on the lives of most Americans. LIBOR is the average interest rate that large banks in London charge to one another to borrow money. The rate charged between banks in London turns out to be the basis for the interest rates on more than $350 trillion in loans and derivative contracts. And, the rate impacts the interest rate we pay on everything from adjustable rate home loans and auto loans to credit cards and almost all other kinds of credit.

Eighteen large, London-based banks daily report their cost of borrowing to the British Bankers Association; those values are averaged and then LIBOR is published. If the rate the banks report is high, it means either (1) that interest rates are high or (2) that lending money to the bank is perceived as risky because of its potential for default. Recently, Barclays admitted to lying about the rate it was being charged to borrow money, and the bank paid a $453 million fine to U.S. and British government authorities for doing so. At first Barclays claimed that it lied about manipulating LIBOR because the bank did not want to admit that other banks were afraid to lend Barclays money. But now there is evidence that potentially many banks were lying about their actual borrowing costs so that they could profit on derivative trades where payoffs are dependent on the level of LIBOR. That the very banks that set LIBOR also get to trade derivatives tied to the index, well, that is what we call “letting the fox guard the hen house.”

You should be angry because it appears that Barclays is not alone in manipulating LIBOR; in fact, the practice was a bit of an open secret among many banks. Sometimes these manipulations saved you money by lowering your interest rates. Longer term, these manipulations make our credit markets less efficient and result in higher overall rates for everyone. The one positive note is that the U.S. Department of the Treasury is taking the lead to clean up the way this important interest rate measure is calculated. It’s nice to see the United States taking the lead, at least in this instance, in making sure that the public is treated fairly.

Dream a Little Dream: Know where you want to go

July 10, 2012

People often think defining an investment strategy is the first step in creating a solid financial plan. Slow down. Before you even begin to gather all the information you’ll need to form an investment strategy, sit down on the porch or patio or in front of the fireplace (with your spouse or partner if you have one) and let your mind roam.

What do you really want from life? If you could do anything you want, what would you do? Don’t put financial restrictions on yourself now. Dream. Stretch a little. Once you have that dream defined and you know roughly where you want to go, you can begin to determine what role a financial plan can have in helping you live that dream. 

A good investment strategy begins by identifying your specific individual goals and the time you have to achieve them. Those highly personal decisions, very often driven by your love of others, will suggest your strategy. Your strategy may include shorter- and longer-term objectives.

Are you investing to buy a house, pay for college or to retire with sufficient income to support the lifestyle you desire? How much money will you want for each objective? When will you need it? How can you get there? Will you have to make trade-offs to achieve those goals? Which take the highest priority?

The answers to all of those questions will help you determine your individual strategy. Without that strategy it is nearly impossible to know how to invest.

The Fiscal Cliff

July 3, 2012

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect.  The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession. 

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.”  Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview.  And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.”  Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.”  Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues. 

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes.  The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not.  So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.

Wealth Enhancement Group