UvA Professor Maarten Pieter Schinkel advocates in-depth and socially relevant economic research but expresses concerns that universities provide less and less room for it. His own research is putting the banking sector through the hoops again.
Once again, Maarten Pieter Schinkel has wound up banks and watchdogs. Together with Timo Klein, PhD student at the UvA and Nuria Boot, PhD student at KU Leuven and the German Institute for Economic Research (DIW Berlin), the Amsterdam professor recently published a model which shows that the Libor rate affair is not just about some fraudulent individual traders. ‘It is well possible that a widely supported cartel has been at work, in which a large group of banks colluded with each other and purposefully manipulated interest rates.’
Their research may affect the outcome of this scandal as the model of the three scholars could enable victims to increase their claims for damages on the grounds of violating the competition law. Watchdogs can use the model to keep a better eye on the banks. Schinkel also believes that the model shows that the recent modifications of the procedure to fix the Libor rate are not completely effective.
Schinkel, who in his own words is a ‘passionate’ practitioner of competition economics, has riled banks and watchdogs before. According to him, banks have, since mid-2009, reaped surplus profits from mortgage loans because the European Commission had completely banned market forces. After the Dutch TV show Zembla covered Schinkel’s findings, the European Commission changed its policy while the importance of competition within the banking sector landed on the political agenda of Dutch finance minister Dijsselbloem.
Schinkel speaks about his investigations with great enthusiasm: ‘Economic scholars need to bridge the gap between issues in society and fundamental research. The history of economic thought clearly shows that almost all great economists demonstrated a strong commitment to society.’ But there are worries: ‘Unfortunately, bridging the gap can no longer be taken for granted. Digging into the causes of complex real problems is a time-consuming activity as you need to acquire a profound knowledge of what is going on first. Only then can the essential mechanisms be uncovered and modelled, data collected, and finally model and data analysed combined.’
According to Schinkel, less and less time is available for research of this nature. ‘Scholars are increasingly pressured to publish specifically and frequently, and the result of this is research that builds in small increments based only on already published research. This is more efficient in terms of speed and taking risks, but it also means that major social issues remain untouched.’
Schinkel grants that this approach to research is not without merits, but ‘in my opinion, the key challenge faced by the discipline of economics is to engage in research that is relevant both academically and for society.’ Schinkel does not care much how this research finds its way to the public. ‘As far as I am concerned, a TV news show such as Zembla and a background article in a quality newspaper are just as important as a publication in a prominent academic journal. Eventually, I aim for both - and the best economic journals are open to this - but such projects take years to complete. And someone needs to give you that amount of time.’ This is very important to Schinkel, because for him, universities are the place for independent, objective and in-depth research: ‘Where else could this be carried out?’
Schinkel’s determination to uncover deep social issues was the starting point also of his remarkable analysis of the Libor scandal. In this affair, traders employed by major banks have been suspected of manipulation of the Libor rate. Since 2012, investigations have resulted in billion dollar penalties handed out to banks in the US and Europe and criminal trials against some of their traders. Rabobank agreed to a 800 million euro settlement with American and European watchdogs.
The Libor rates are the benchmark interest rates, in various currencies, for short-term loans and are used to set the rates for financial products such as interest rate derivatives and mortgage loans. The rates are calculated in London every day. Each of the sixteen banks belonging to a permanent panel submit the rate that reflects their capacity to do transactions. After trimming off the top and bottom four estimates, the average of the remaining estimated rates is published as the day’s official rate.
Most convictions and settlements concerned fraudulent behaviour by selected individual traders who, by mutual arrangements, would have rigged the interest rates for their personal enrichment. The financial watchdogs treated these cases as breaches of the banking code of conduct. By now, the European Commission has also reached settlements, and has issued decisions, establishing cartel violations. The details of these cases are unknown as yet.
‘At first, I was critical of these cases as I could not see how cartels of this type could work,’ says Schinkel. ‘A regular cartel, for instance a beer or a shrimp cartel, is formed by colluding parties all benefiting from rising product prices. But here, manipulating the Libor rate has different effects for different banks, because they often have adverse positions whose value is partly determined by the Libor rate.’
A tip from an anonymous source turned Schinkel’s view around. ‘This insider pointed out to me that not only did the panel banks mutually agree on the direction in which the interest rates would move, they also adjusted their positions in the hours before the publication of the official Libor rate.’ The researchers then built a model which shows that all the banks involved can make profits in the long term if they make deals on the interest rates and adjust their own positions accordingly. ‘There may be a few periods with individual losses, to serve the cartel, but eventually everybody can expect generous cartel profits.’ This was actually a cartel based on insider knowledge; this inside-information of the future Libor rate was created by the cartel itself, at the expense of other market parties such as pension funds and banks who were not in the 16-bank panel.
Schinkel has no information about how the European Commission formulated its charges. ‘The infringement decisions are still confidential, but I expect that they will be built on evidence of the kind of mechanisms that our study has uncovered.’ The professor is surprised that collusion is so underrated in the general discussion on supervision and the Libor-reform. ‘Let’s hope that our model will be of use to the Commission and national supervisors.’
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