The book known as Principles of Money Banking and Financial Markets written by Lawrence Ritter and William Silber has an interesting approach in discussing Monetarism, the Classical Interest Theory and most equivocal of all, interest rates. Classical economics teaches that the conservation or saving of any amount of funds along with investing are functions of interest rates. Peoples’ amount of spending and businesses’ amount of investing moves along with interest rates as they fluctuate. As people become more induced to restrain their spending as interest rates increase, more funds become conserved. Investments are placed into capital goods (buildings, equipment, land, and other things used in producing) for the sake of furnishing the paraphernalia necessary for producing goods and services in the future that will reap monetary gains exceeding the cost of whatever capital was acquired during the time of investing. A particular paragraph in the book states this: “A lower rate of interest will induce entrepreneurs to invest in projects of lower expected profitability, because the cost of borrowing funds is less.”
If I am a business enterpriser, why would lower interest rates at any time compel me to invest in projects harvesting lesser monetary earnings when my primary goal in business is always to harvest as much monetary earnings as I possibly can? The only effects interest rates have on my capital are what and how much goods and services they attract my customers to buy from me. Moreover, it is while interest rates are lower when consumers buy more than they do retain in their pockets or bank accounts. So, if I am to receive more funds from consumers in having them buy more of my goods and services, why would I invest in projects harvesting lesser monetary earnings? I cannot be investing in projects harvesting lesser monetary earnings if consumers are more prompted to purchase my goods and services because of lower interest rates. Secondly, the effects interest rates have on my capital and means of production, or rather, what determines the type of capital and means of production I will acquire is the price I will incur upon myself or what I must pay on interest through investing in whatever capital and means of production needed.
The book goes on to further explain: on the supply of funds curve (people’s savings) and a demand for funds curve (business enterprisers’ demand for investment), very seldom do the savings and investment lines decussate with interest rates at equilibrium in the center spot on the plot diagram or graph. At this point, during the time of total savings and investments being equal, when all borrowers are free to borrow and all lenders are free to lend, the condition is always fugacious. When interest rates are beneath equilibrium, business enterprisers desire to receive more funds than what savers are free to yield or consumers are able to buy and competition drives prices or interest rates higher. When interest rates are above equilibrium savers desire to yield more funds or consumers desire to spend more than what business enterprisers desire to invest and competition drives prices or interest rates lower.
The words above make it seem as though consumers and businesses as well as the climate of the economy arbitrarily cause interest rates to fluctuate, but this should be called into question when central banks, one known in America as being the Federal Reserve, in servitude to their most affluent private stockholders of their nation’s most mammoth commercial banks, play a major role as controllers of the dial on interest rates. The Federal Reserve changes the interest rate policy based on the behavior and financial activities of consumers, savers and investors to help balance the economy, supposedly, according to conventional thought. The Federal Reserve since its very nascence has been portrayed as an institution with the sole intent of being an intervening stabilizer and giver of restitution when the economy turns parlous. Nothing can be further from the truth. The Libor Scandal, being one of many situations, helps to corroborate this. The world’s greatest megabanks are controllers of the dial on interest rates as well, which will be revealed very soon. But for now…..
The Current Brewing Scandal
In July of 2012, the New York Federal Reserve disclosed a document dating back to the year 2007 revealing their utter awareness about the banks’ legerdemain in reporting their borrowing costs while situating Libor. Documents express that memorandums were exchanged, as can be seen with this memorandum that was sent by then-New York Fed President, Timothy Geithner, to the Governor of the Bank of England, Mervyn King, concerning recommendations on how to restructure Libor. Meetings and phone calls were made between Federal Reserve officials and bankers that included “Market Group analysts engaged with market participants” for “identifying the nature and location of rapidly mutating financial stress.” Briefing notes were dispatched from Federal Reserve officials to U.S. Treasury Department officials and circulated amongst other U.S. agencies. Many recommendations for reform were made, but there is no documentation evincing that any of the recommendations were initiated or enforced to take effect. In late October of 2008, a few months following Geithner’s memorandum to King, a Barclay’s representative communicated to a New York Fed official that Libor’s numbers were still “absolute rubbish.” The Federal Reserve displayed counterfeit intentions for thwarting the banks’ collusion and fulfillment of their objectives.
Mervyn King, the Governor of the Bank of England, knew just as well as anyone else about the scandal since 2008 considering he spoke at the British Parliament at the end of 2008 saying "It is in many ways the rate at which banks do not lend to each other. .. It is not a rate at which anyone is actually borrowing."
In April of this year, the mainstream media outlet, Rollingstones.com, conceded to the truth about the world’s hugest megabanks manipulating prices and interest rates. The article succinctly and simply discusses the Libor Scandal as quintessentially exemplifying how corrupt banking institutions and practices are exploited paramountly for the goals of our aristocrats and oligarchs to be achieved. According to Rollingstones.com, the Libor Scandal may soon have a “twin brother” involving ICAP, an electronic broker established in London that services aid after trade risks are taken and is the world’s most enormous transactor for financial institutions involving interest rates, interest rate swaps, credit, credit derivatives, foreign exchange, intellectual property and equity derivatives. Scrutinizers suspect ICAP’s activities with 15 of the world’s foremost megabanks include the ISDAfix, another leading benchmark or supposed standard of excellence, much like Libor, unto which annual rates for global transaction swapping are compared, measured, and judged. It is a screen service displaying the average mid-market swap rates for six vast monetary currencies fixed at certain maturities on a daily basis.
The Libor Scandal
The Libor (London InterBank Offered Rate) contains an assortment of derivatives valued in total at $350 trillion and is shepherded by the British Bankers' Association (BBA) who receive the final submitted interest rate reports from 20 of the world’s biggest banks at 11 o’clock each morning. Wikipedia.com tells us the Libor represents one aggregate interest rate averaged by the computations made via the interest rate data presented by major banks in London. Knowledge.Wharton.edu tells us there are computations in 10 different currencies for 15 loan terms each varying from overnight to 12 months. The rules of the game oblige banks to put forward the actual interest rates they are paying, or are expecting to pay, in recompense for what they borrowed from other banks. The Libor is purposed for being the total appraisal of the financial system and its state of health. If commercial banks, those membered with their nation's central bank, feel hopeful about the status of the financial system, they will submit a low number. If these commercial banks are unhopeful about and discontent with the status of the financial system, they will submit a higher interest rate number.
It is jaw-dropping to know that Libor is a standard of excellence in theory only, upon which the world’s 20 biggest banks assess their borrowing possibilities without complete accuracy and verification of their assessments leading them in the direction of making decisions that are wise and the least venturesome. Instead of representing what they truly will owe in the future, the Libor represents what banks expect to owe or repay in their borrowing and lending transactions amongst each other on a daily basis.
Linked to the Libor was a sequence of extortionate dealings along with a subsequent inspection of the matter that commenced after information was leaked about banks fraudulently inflating or deflating their rates to illegitimately generate revenue from trades and speciously upgrade their creditworthiness. During the process the BBA removes the top 25 percent and bottom 25 percent of market data relating to securities and commodities, calculating the average afterwards. If a bank submits data in the bottom quarter when its real rate is in the top quarter, the rate of another bank has the possibility for ascending into one of the middle quarters. Low rates meant for being expunged instead become used in the calculations. In June 2012, leaked information concerning multitudinal illicit negotiations that were made by Barclays Bank unveiled a momentous conspiracy between other commercial banks such as the Royal Bank of Scotland, HSBC, Deutsche Bank, JP Morgan Bank, Citibank and many more to defraud other participants financially inferior to them in the market using the interest rate submissions.
Since Libor is used in United States derivatives, any manipulation executed in Libor is an infraction upon American financial markets, American property and American law. As a consequence of adjustable-rate mortgages, student loans, automobile loans and a wide array of other multifarious financial products being appraised according to Libor, the contortion of the submitted interest rate numbers used to gauge the rates of all the derivatives therein emanates a wave of malfunction all throughout the financial markets of the globe, impinging consumers and investors of all types. As a result of this scandal, the banks have caused people to pay the wrong interest rates on a number of financial products too many to enumerate.
Interest Rate-Swaps
An interest rate swap is a derivatives mechanism that is eminently liquid and attractive. It is used between two counterparties (i.e. legal entities, unincorporated entities or a conflation of entities subjected to the financial risk) who have contracted to trade one stream of interest payment for another. Swaps always consist of an exchange between a fixed-rate and a floating rate with a notional principal amount, defined as being the initial total amount of an asset or bond possessed by someone.
Interest rate swaps are ordinarily used in hedging and speculating. Hedging involves having an investment status purposed to compensate for possible losses that a separate accompanying investment may become liable or subject to. Hedging accommodates in retrenching any considerable losses affecting an individual or institution. It comprises of financial instruments such as stocks, exchange-trade funds, insurance, forward contracts, and other derivative products. Speculating involves participating in financial transactions fraught with danger in hopes of profiting from short or medium term vacillations in the market value of an exchangeable good or financial instrument instead of profiting from the fundamental financial facets of the instrument such as capital gains, interest or dividends. Speculators are commonplace within stocks, bonds, commodity futures, currencies, fine art, collectibles, real estate, and derivatives.
Interest rate swap transactions require each counterparty involved to pay a fixed or floating rate denoted in specific banknotes to the other counterparty. The fixed-rate or floating rate is multiplied by a notional principal amount and a factor of accumulation prearranged by a befitting day count convention.
The day count convention appraises how interest accumulates over time for a mélange of investments, including bonds, notes, loans, mortgages, medium-term notes, swaps, and forward rate agreements (FRAs). This estimates the number of days between two coupon payments, which, when pertaining to bonds, are intervallic payments of interest that the bondholder collects between the date of the bond’s issuance and its date of maturity. The day count convention gives a reckoning in regard to the total sum in need of being remitted on its due date and also the accumulated interest for dates between remittances. The day count is also used to measure periods of time when a cash stream’s interest is deducted to or denominated in its present value. When a security such as a bond is dealt between the deadlines by when interest payments must be fulfilled, the seller is qualified for receiving some portion of the coupon amount.
The present value is the subsequent monetary sum that has been discounted to mirror its current value as if it existed today. The present value is constantly smaller than or equivalent with the subsequent value for the reason of money having the prospect of accruing interest, a attribute known as the time value of money that is a notion at the core of finance theory. This is the worth of money calculated at a certain quantity of gained interest or inflation accumulated throughout a period of time. The criterion proposes that a particular quantity of money today differs in its buying power from the same quantity of money in subsequence. The prospect of accruing interest on a sum of money and inflation raising prices, whereby altering the worth of the money, is the reason for the existence of this principle.
In returning to discussing the operations of interest rate swaps, counterparties do not regularly trade the notional principal sum when both legs of the switch are in the same currency. Instead, the notional principal amount is used only for appraising the volume of cash streams to be swapped. It is normally switched in the beginning and at the finish of the interest rate swap when the legs of the switch are in different currencies.
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