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by Michael Cohen
The Libor actually makes the regulators look far more incompetent and culpable than the admittedly dishonest banks. No variable rate contracts should be enforced by any government until the standard is made objective and verifiable.
Very briefly derivatives and other variable rate contracts such as derivatives and mortgages are pegged to the Libor which at best represents large banks subjective estimates of what banks loan money to each other and at worst represents a rate fixed by collusion between the banks. It would be easy using private bank data acccessible to regulators to construct an objectively based rate.
The question remains why the state is willing to enforce contracts based on this rate when an objective estimate is easily obtained from the banks by sampling their loans. The state would not enforce a contract with data obtained by asking the opinion of the Mafia or your or my opinion so I do not see why the state chooses going forward to enforce contracts based on the Libor until such time as either some regulatory agency or Thomson -- Reuters produces a rate which is objective and appoximates the Libor. By objective I mean actually verifiable data.
The Cardinals of the Catholic Church could legislate a moral interest rate which could be used to peg variable rate securities and as long as it is self--enforcing and everybody agrees to the terms there really is no problem as long as everyone is willing to live with the subjectivity. However, the Libor is supposed to represent something objective and until it does I fail to see why anybody who does not have religious failth in the probity of banks would pay a rate based on the libor unless it was extremely favorable. Likewise, its hard to see how this subjective rate set by modern versions of the Mafia Dons could be enforced by the state. The standards of the Libor might have befit a pre-modern era but at this time there is no reason for an enforced subjective standard.
:: photo courtesy of Simdaperce via Creative Common license ::
Michael Cohen is a professor of Cognitive and Neural Systems and Computer Science at Boston University.