How the Libor Scandal Affects You
Are you suffering from financial scandal fatigue? I know I am. Just when it seemed public opinion of bankers couldn't possibly sink any lower, along comes the Libor investigation, further blackening the reputations of America's big banks, along with some of England's most venerable financial institutions, and the regulators who're supposed to be watching over them.
Before you click away to a less depressing topic, there are a few things small business owners need to know about the Libor mess:
1. It's just getting started.
Banks are accused of manipulating Libor (for London interbank offered rate), the rate at which they say they will lend each other money. Libor is used in calculating interest rates for many loans. But Libor is derived from a poll of many banks, and the highest and lowest numbers are eliminated as outliers. In other words, it's rigged so that it can't be manipulated by a single bank, and it wasn't. Many, many financial institutions were involved in this, and many, many lawsuits and criminal investigations are on their way. Before it's over, experts expect that banks will have paid out tens of billions in damages.
One likely result is that interest rates are likely to rise substantially from their current levels.
2. You may have benefited.
Sounds crazy, doesn't it? But what banks are accused of doing, especially during the depths of the financial crisis in 2008, is manipulating Libor rates down. Why would they want to lower Libor and thus make less money on the loans they wrote? To make themselves and the banking industry in general appear solid at a time when faith in banks was approaching Depression-era levels.
Lowering Libor rates lowered interest on many loans, since Libor is used to calculate interest rates in general--Libor plus 1% for low-risk large corporate borrowers, Libor plus 3% for consumer borrowers and so on. If (like me) you took out a loan or refinanced a mortgage during the depths of the crisis at the incredibly low rates available then, you can thank those dishonest bankers for doing you a favor.
3. Your town may have suffered.
The big losers in the Libor manipulation are municipalities, states, and towns. That's because many municipalities engaged in interest rate swaps with banks. Municipalities would sell bonds at fixed rates, but then pay interest on them using variable rate payments they received from banks. Their budgets were squeezed when those payments were artificially lowered by bankers. So if your local school is laying off teachers or your township can't afford to fix its roads, those bankers are partly to blame.
4. Don't sit on your hands.
"To the extent small businesses have responded to these scandals, it's been by sitting on the sidelines and hoarding cash," says Evan Segal, a former business owner and author of From Local to Global. Segal served as chief financial officer at the U.S. Department of Agriculture under president Obama. Without confidence in the banking industry or in government, he says, small businesses have resisted doing capital investments or taking on debt.
But that doesn't mean you shouldn't be making changes. "You have two options: Sit on the sidelines and hope to get through, or seize the opportunity to improve your business," Segal says. "What can you do now so when the recovery comes back you're better positioned for growth?" One area he suggests examining is business process improvement.
For example, he says, you may think it takes accounting just a few steps to pay an invoice, but with multiple workarounds, it may take many more. Use down times to practice Lean or Six Sigma methodologies and eliminate this kind of waste. "Now you've freed up cash you can invest in product development and inventories and marketing so while everyone else is in wait-and-see mode, you're planning for growth."
4. Consider a community bank.
Citigroup and Bank of America, two of the three largest banks in the U.S. may be implicated in the scandal, and the investigations aren't over yet. One possible effect of the ongoing Libor mess is that scandal-fatigued employees may be more reluctant to contribute to 401(k) plans. After all, they might well reason, if the banks are crooked and interest rates are phony, why bother?
One way to alleviate these concerns, and perhaps to help your home town too, is to switch to a smaller, community-based bank or credit union.
"As a small business person, I always felt these things were out of my control," Segal says. "Traders and senior banking people were manipulating the rates, and all I got was the backlash. Moving to community banks would be one action small business owners could take."