Last month, one of the biggest financial scandals in history came to light, involving many of the most pre-eminent banks in the world. But public reaction has been so muted that a Los Angeles Times columnist was compelled to ask, “Why aren’t more people furious about the Libor scandal?”
In fact, people are.
The news media soon will be full of stories of outrage concerning the London Interbank Offered Rate (Libor), the daily interest calculation that underlies hundreds of trillions of dollars in loans and option transactions; about how Barclays and other international banks managed to manipulate it to bolster profits and buttress their stock prices, and how the manipulations subverted capitalism, robbed pensioners.
Regulators, congressional investigators and plaintiffs’ attorneys are massing around the scandal, ready to attack both banks and U.S. and U.K. bank regulators who, some allege, knew about a persistent pattern of rate manipulation and cartel-like behavior but turned a blind eye.
Treasury Secretary Timothy Geithner, for example, will be grilled about how much he knew about Libor manipulations when he headed the Federal Reserve Bank of New York. According to the Washington Post, the New York Fed had received “occasional anecdotal reports from Barclays of problems with Libor” beginning in 2007, enough that in 2008, Geithner asked British officials whether the rate was being manipulated.
According to numerous media reports, officials in California, Connecticut, Florida, New York and Maryland are looking into possible legal action against the banks, blaming Libor manipulation for higher borrowing costs and lower investment yields that affected public treasuries. Joe Dear, head of the California Public Employee Retirement System, the nation’s biggest public pension fund, which has been beset by falling investment yields since 2008, called for prosecuting bank executives if it is shown that the Libor manipulations affected long-term investors such as pension funds.
Every weekday morning before 11 a.m. GMT executives at up to 19 large banks, including three U.S.-based banks that participate in the London Interbank money market, provide what the British Bankers’ Association (BBA), which runs the Libor-fixing process, terms its “lowest perceived rate” for inter-bank loans at that moment. It is an estimate of what interest they would be charged that day for unsecured loans from other banks.
The rates are averaged together with the four highest and four lowest figures tossed out. The results are reported as that day’s Libor rates, published by Thomson Reuters.
The Libor rates immediately become that day’s benchmarks for pricing a vast number of loans, securities and derivatives around the world.
Libor affects the health of pension plans and city and state budgets, the profits and losses for derivative traders, and rates for mortgages, student loans, auto loans and small-business lending.
From at least 2005 until 2009, according to investigators for the U.S, U.K. and the European Union, some of the participating banks gamed the Libor rate. When Libor rates rose, consumer and business borrowing became more expensive. When Libor rates fell, investment yields were reduced. When Libor rates were manipulated, there were winners and losers, depending on the direction of the manipulation. What was clearly sacrificed, however, was the integrity of the banking system.
First up, Barclays
Barclays was the first and so far the only bank to admit it manipulated the Libor rate between 2005 and 2009, in a settlement with U.S. and U.K. regulators in June. Its CEO, Robert Diamond, Jr., has resigned despite claiming he knew nothing about the false submissions. The bank has agreed to pay U.K. and U.S. regulators $453 million in civil fines.
Investigators believe it would have been impossible for Barclays to increase its profits and or reduce losses from false reports without acting in collusion with other banks. According to the New York Times’ DealBook, HSBC, Citigroup and JPMorgan Chase are among other Libor-setting banks being investigated. Bloomberg BusinessWeek reports that the EU Competition Commission views the collusion as “a cartel arrangement.”
Investigators say two motives influenced Barclays’ manipulation of the Libor rate. E-mails throughout the four-year period show bank traders brazenly requesting bank executives’ help in forestalling an anticipated move in the Libor rate to protect profits from a particular trading position, then thanking those executives, saying things like, “Dude. I owe you big time!”
Then, as the financial crisis of 2007-2008 evolved, the banks had institutional incentives to manipulate the rates.
When the Libor rate is published, the individual banks’ submissions are published along with it. The bankers knew that investors, analysts and regulators could use that information to gauge each bank’s financial health during the financial crisis beginning in 2008. Quoting a lower borrowing rate conveyed that the bank had more reserves than it really had, and tended to boost Barclays’ stock price at a time when reserves were thin.
Much still remains to be discovered about both the scandal itself and its effects on the economy, leading into and following the Wall Street collapse. At this point, it is unclear who the winners and losers were, but it is possible that some of the financial institutions preparing to sue for losses will learn, when all the facts are known, that the unplanned effect of Libor manipulation was to improve their financial positions.
The biggest cost to be borne by businesses and investors is arguably going to be destroyed confidence in the banking system, and in the leadership of the major banks.
As many commentators have noted, the Barclays’ emails show major, respected institutions infected with greed – a dramatic change from the staid image of bankers as risk-averse professionals who cared about the soundness of their banks above all.
The banks were permitted to establish Libor, a crucially important benchmark for capital, without any regulatory oversight only because every financial entity that used Libor as a benchmark for pricing loans assumed the world’s leading bankers could be trusted. That presumption of trustworthiness is gone, but it is uncertain what can replace it.
••• John Stodder is national affairs correspondent for The Mississippi Business Journal.
– John Stodder