The Libor scandal last week assumed for the first time the faint outline of a dispiriting caper movie. The Wall Street Journal reported on new details that have emerged about a suspected ring of thieves (subscription required) – “more than a dozen traders from at least nine banks, often allegedly working together in small groups to target different interest rates on separate continents … a wide conspiracy that continued for several years and cascaded around the world.”

Thomas Hayes, a trader who worked for the Swiss bank UBS from 2006 until 2009, surfaced as a central figure in various probes. Citigroup hired Hayes away in 2009 and fired him the following year, according to the WSJ.

So far no criminal charges have been filed – against Hayes, other traders whom he is alleged to have enlisted, or their supervisors.   Not yet.

But as the WSJ previously reported, Hayes was the central figure in a civil action against UBS and Citigroup brought by Japanese investigators last year. And new information, adduced from court filings by reporters Jean Eaglesham and David Enrich, shows that traders have told Canadian regulators, too, that Hayes “worked closely at several banks to push yen Libor submissions up and down” and “also tried to rig rates through employees at brokerage firms that supplied information to banks on the yen Libor panel.”

The broad investigation, which involves US, UK, and European authorities as well, is continuing.  Evidence in emails, instant messages, trading records and direct testimony is piling up

And since the Hayes story (and whatever others like it may emerge) is very different from two other aspects of the rate-rigging story – the intramural misreporting scandal among the banks that made headlines earlier this month when Barclays bank agreed to pay a $450 million fine; and the question of what regulators did and failed to do about various shady practices – it is important to distinguish, early and often, among the three distinct rings of the Libor circus

The story starts back in 1985.  That’s when, as part of the deregulation of British banking, the Londoninterbank offer rate (Libor) first began to be derived daily by the British Banking Association from the best-guess estimates of fifteen major banks.  Libor was to be the semi-official prime rate: the rate at which, as Bank of EnglandGovernor Mervyn King later put it, the biggest banks were not lending to one another – the rate that each bank estimated it would be charged if it were borrowing in the interbank markets.

Libor was designed to mitigate haggling, That it did, quickly becoming a banking standard for commercial lending around the world, quoted in US dollars and British pounds,  spawning imitations for the euro and the yen. As part of its own deregulation of financial markets, US Treasury’s Undersecretary for Monetary Affairs Edwin Yeo III in the late 1970s was broadening the maturity spectrum of US Treasury debt and making its calendar more regular, and for the same purpose, as noted by Kenneth Garbade in Birth of a Market:  The US Treasury Securities Market from the Great War to the Great Depression (MIT Press, 2011).  Why the banking standard didn’t become US Treasury rates plus an appropriate measure of compensation for risk makes an interesting question.

For the Libor standard proved to be vulnerable on a number of grounds.  For one thing, it was not based on specific transactions; instead it involved bankers’ judgments.  For another, only a small number of banks were involved.   And finally, in the crisis, Libor came to be something else:  Compared to the price of overnight indexed swaps, the spread between one price and the other became a measure of the difficulty particular big banks were having attracting funds (hence the incentive to particular banks to underestimate their Libor rates, so that they wouldn’t look as risky as the market might actually have thought they were).

It was in that context four years ago that WSJ reporters, prompted by, among others, economists at the Bank for International Settlements  (and presumably encouraged by short-sellers in various markets), began writing about the possibility that Libor was being systematically understated (“Libor Fog: Bankers Cast Doubt on Key Rate Amid Crisis,” by Carrick Mollenkamp). They have more or less owned the story ever since. Mollenkamp last October left the Journal after fourteen years for Reuters.)

Thus it was in the Go-to-Jail ring that lights were flashing last week. The suspicion here is that bands of fixed-rate robbers learned at some point to manipulate the daily Libor rate to their advantage, then placed big bets on sure things. Swings of even a single basis point or two (one-hundredth of a percentage point) could yield fortunes over time to those who knew to expect them, given the enormous size of markets based on Libor (trillions on debt itself, hundreds of trillions of nominal value in derivatives).  Opportunities may have grown sharply as the financial crisis deteriorated.  This is essentially a story about possible burglary rings that that may have turned to outright looting in the crisis.

Then there is the Central Banking ring.  It was here that the storm raged earlier this month after Barclays bank agreed to pay about $450 million  to settle a series of investigations of its Libor practices. The plan originally had been to blame the matter on a handful of bad apples (e.g., would-be burglars) within the bank who had been fired. But when anger boiled over in London political and banking circles that the top officer, US citizen Robert Diamond, had not been named, Diamond responded with a daring defense.  The Bank of England had made him do it, his spokesman implied – that is, deputy Governor Paul Tucker had evinced half-knowledge of widespread reporting irregularities among Libor banks as the central bank sought to stave off incipient panic. (Remember, to report a higher than average Libor rate was to admit the difficulty of raising funds, and risk the beginning of a run.) Without acknowledging such concerns, the Bank of England privately but forcefully demanded that Diamond be fired the next day. And so he was. (All this according to WSJ news reports.)  Legislators on both sides of the Atlantic have  been tentatively grilling central bankers ever since about their actions during the crisis, including US Treasury Secretary Timothy Geithner, who has been president of the Federal Reserve Bank of New York, in which role he had oversight of financial markets, including, in the borderlands of his purview, Libor.  The lesson has mostly gone untaught, much less learned, that central banks in crisis times must tolerate individual banks’ practices they would in normal times abhor, in order to preserve the banking system.

A sideshow has developed, as it often does, on the editorial page of the WSJ.  The writers there have been intent on ignoring or even discrediting their own reporters and blaming matters on the regulators, much as they did in the options backdating scandal that the paper broke in 2006.   Libor is “a lesser scandal than the outrage would suggest,” they say, “another excuse to blame the bankers and give even more power to the same regulators who missed or abetted the scandal.”   In fairness I can understand the WSJ  editorialists frustration – their counterparts at The New York Times last week were touting CommodityFutures Trading Commission chairman Gary Gensler for the next Treasury Secretary, on grounds that the nation’s revenue raiser and debt manager somewhow needs a regulator in charge.

But you wish the Journal editorial writers would spend a little more time explicating the extraordinary work the paper’s reporters have done and less time denouncing against “the regulators and their media cheerleaders.” Hardly any knowledgeable person thinks Libor was “a vast criminal enterprise,” as the editors mischaracterize critics’ views (though an oped in the Friday Financial Times by Douglas Keenan, a former trader for Morgan Stanley now working as an independent mathematical scientist, maintained that its tendency to understate true market conditions was common knowledge as long ago as 1991).  But Libor certainly seems to have been a very sloppy standard, whose vulnerabilities routinely favored those who devised and maintained it.  Thanks to WSJ reporter Mollenkamp and his many fellows, an invaluable audit of banking sector practices is underway.

Indeed, the main ring of the Libor circus, I suspect, will turn out to be the bank management ring.  Should management have known about various manipulations that were occurring within their banks?  “Some of the banks swept up in the world-wide interest-rate probe have noted the difficulty of policing the conduct of thousands of employees, including traders who were in position to profit from interest-rate rigging,” wrote WSJ reporters Eaglesham and Enrich last week.   But might that be evidence that they have become too big to manage?  Or, as in the case of the $5 billion loss engendered by J.P. Morgan’s “London whale” (another WSJ story, by the way), evidence that such banks were statistically all but certain to fail?

It was into this debate that former Citgroup chief executive Sandy Weill, stepped last week, arguing in a CNBC interview that the big banks should be broken up.  There has been a growing chorus of opinion among regulators, politicians and bankers arguing for some kind of separation  of banks by function.  The significance of Weill’s opinion is that he engineered the first financial mega-merger, when as head of Travelers Group. he merged with Citicorp, flouting the 65-year old Glass-Steagall Act and daring regulators to do something about it. (He subsequently pushed out Citigroup chief executive John Reed and assumed the post himself.)   It is increasingly clear, it seems to me, that the temporary mash-up of financial institutions that was engineered in the course of a few months during the 2008 emergency will be reversed.  The real question is how.

That leaves the Post-Circus Feast.  As noted by Mollenkamp in his original story. “Fibbing by the banks could mean that millions of borrowers around the world are paying artificially low rates on their loans.”  It now appears they were.  That may have been good news for the borrowers, but it is bad news for the lenders, the banks who turned around and sold the cashflow from those loans as asset backed securities.  The investors who bought those securities may now have a legal claim against the banks that sold them.  Lawyers will be dining out for years on the aftermath, long after the Libor circus has left town.