Libor Scandal

Libor Scandal

The Libor scandal is a series of fraudulent actions connected to the Libor (London Interbank Offered Rate) which the resulting investigation and reaction. The Libor is an average interest rate calculated through submissions of interest rates by major banks in London. The scandal arose when it was discovered that banks were falsely inflating or deflating their rates so as to profit from trades, or to give the impression that they were more creditworthy than they were. Libor underpins approximately $350 trillion in derivatives. It is controlled by the British Bankers' Association (BBA).

The banks are supposed to submit the actual interest rates they are paying, or would expect to pay, for borrowing from other banks. The Libor is supposed to be an overall assessment of the health of the financial system because if the banks being polled feel confident about the state of things, they report a low number and if the member banks feel a low degree of confidence in the financial system, they report a higher interest rate number.

Because Libor is used in U.S. derivatives markets, an attempt to manipulate Libor is an attempt to manipulate U.S. derivatives markets, and thus a violation of American law. Since mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.

On July 27th, 2012, the Financial Times published an article by a former trader which said that Libor manipulation has been common since at least 1991. Further reports on this have since come from the BBC and Reuters.

Early reports of Libor manipulation

WSJ Libor study

On 29 May 2008, The Wall Street Journal (WSJ) released a controversial study suggesting that some banks might have understated borrowing costs they reported for the Libor during the 2008 credit crunch that may have misled others about the financial position of these banks. In response, the BBA claimed that the Libor continued to be reliable even in times of financial crisis. Other authorities contradicted The Wall Street Journal article saying there was no evidence of manipulation. In its March 2008 Quarterly Review, the Bank for International Settlements stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings." Further, in October 2008, the International Monetary Fund published its regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar Libor-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar Libor remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding."

A study by economists, Snider and Youle, in April 2010, however, corroborated the results of the earlier Wall Street Journal study that the Libor submissions by some member banks were being understated. Unlike the earlier study, Snider and Youle suggested that the reason for understatement by member banks was not because the banks were trying to appear strong, especially, during the financial crisis period of 2007 to 2008, but rather, because the banks sought to make substantial profits on their large Libor interest linked portfolios. For example in the first quarter of 2009, Citigroup had interest rate swaps of notional value of $14.2 trillion, Bank of America had interest rate swaps of notional value of $49.7 trillion and JP Morgan Chase had interest rate swaps of notional value of $49.3 trillion. Given the large notional values, a small unhedged exposure to the Libor could generate large incentives to alter the overall Libor. In the first quarter of 2009, Citigroup for example reported that it would make that quarter $936 million in net interest revenue if interest rates would fall by .25 percent a quarter and $1,935 million if they were to fall by 1 percent instantaneously.

Central banks aware of Libor flaws

The Governor of the Bank of England, Mervyn King, by the end of 2008, described the Libor to the UK Parliament 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."

The New York Federal Reserve in July 2012, released documents dating back to 2007 which showed that they were aware that banks were lying about their borrowing costs when setting Libor and chose to take no action against them at that time. Released minutes from the Bank of England indicated similarly that the bank and its deputy governor Paul Tucker were also aware as early as November 2007 of industry concerns that the Libor rate was being underreported. In one 2008 document a Barclays employee told a New York Fed analyst, "We know that we’re not posting an honest LIBOR, and yet we are doing it, because if we didn’t do it, it draws unwanted attention on ourselves."

The documents show that in early 2008 a memo written by then New York Fed President Tim Geithner to Bank of England chief Mervyn King looked into ways to "fix" Libor. While the released memos suggest that the New York Fed helped to identify problems related to Libor and press the relevant authorities in the UK to reform, there is no documentation that shows any evidence that Geithner's recommendations were acted upon or that the Fed tried to make sure that they were. In October 2008, several months after Geithner's memo to King, a Barclays employee told a New York Fed representative that Libor rates were still "absolute rubbish."

Regulatory investigations

The Wall Street Journal reported in March 2011 that regulators were focusing on Bank of America Corp., Citigroup Inc. and UBS AG in their probe of Libor rate manipulation. A year later, it was reported in February 2012 that the U.S. Department of Justice was conducting a criminal investigation into Libor abuse.  Among the abuses being investigated were the possibility that traders were in direct communication with bankers before the rates were set, thus allowing them an unprecedented amount of insider knowledge into global instruments. In court documents, a trader from the Royal Bank of Scotland claimed that it was common practice among senior employees at his bank to make requests to the bank's rate setters as to the appropriate Libor rate, and that the bank also made on occasions rate requests for some hedge funds. One trader's messages from Barclays Bank indicated that for each basis point (0.01%) that Libor was moved, those involved could net “about a couple of million dollars”.

The Canadian Competition Bureau was reported on 15 July 2012 to also be carrying out an investigation into price fixing by five banks of the yen denominated Libor rates. Court documents filed indicated that the Competition Bureau had been pursuing the matter since at least January 2011. The documents offered a detailed view of how and when the international banks allegedly colluded to fix the Libor rates. The information was based on a whistleblower who traded immunity from prosecution in exchange for turning on his fellow conspirators. In the court documents, a federal prosecutor for the bureau stated that the “IRD (interest-rate derivatives) traders at the participant banks communicated with each other their desire to see a higher or lower yen LIBOR to aid their trading positions". The alleged participants are the Canadian branches of the Royal Bank of Scotland, HSBC, Deutsche Bank, JP Morgan Bank, and Citibank, as well as ICAP (Intercapital), an interdealer broker.

Barclays Bank fined for manipulation

On 27 June 2012, Barclays Bank was fined $200 million by the Commodity Futures Trading Commission, $160 million by the United States Department of Justice and £59.5 million by the Financial Services Authority for attempted manipulation of the Libor and Euribor rates. The United States Department of Justice and Barclays officially agreed that "the manipulation of the submissions affected the fixed rates on some occasions".

Barclays manipulated rates for at least two reasons. Routinely, from at least as early as 2005, traders sought particular rate submissions to benefit their financial positions. Later, during the 2007–2012 global financial crisis, they artificially lowered rate submissions to make their bank seem healthy.

Following the interest rate rigging scandal, Marcus Agius, chairman of Barclays, resigned from his position. One day later, Bob Diamond, the chief executive officer of Barclays, also resigned from his position. Bob Diamond was subsequently questioned by the Parliament of the United Kingdom regarding the manipulation of Libor rates. He said he was unaware of the manipulation until that month, but mentioned discussions he had with Paul Tucker, deputy governor of the Bank of England. Tucker then voluntarily appeared before parliament, to clarify the discussions he had with Bob Diamond. He said he had never encouraged manipulation of the Libor, and that other self-regulated mechanisms like the Libor should be reformed.

Breadth of scandal becomes apparent

By 4 July 2012 the breadth of the scandal was evident and became the topic of analysis on news and financial programs that attempted to explain the importance of the scandal. Two days later, it was announced that the U.K. Serious Fraud Office had also opened a criminal investigation into manipulation of interest rates. The investigation was not limited to Barclays. It has been reported since then that regulators in at least seven countries are investigating the rigging of the Libor and other interest rates. Around 20 major banks have been named in investigations and court cases.

Congressional investigation

The United States Congress began investigating on 10 July. Senate Banking Committee Chairman Tim Johnson (D., S.D.) said he would question Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke about the scandal during scheduled hearings. Rep. Randy Neugebauer (R., T.X.) chairman of the House Financial Services Committee, wrote New York Federal Reserve (New York Fed) President William Dudley. He was seeking records of communications between the New York Fed and Barclays between August 2007 and November 2009 related to Libor-like rates.

Parliamentary investigation

Appearing before Parliament on 16 July, Jerry del Missier, a former senior Barclays executive, said that he had received instructions from Robert Diamond to lower rates after Diamond's discussions with bank regulators. He said that he had received information of a conversation between Diamond and Paul Tucker, deputy governor of the Bank of England, in which they had discussed the bank’s financial position at the height of the 2008 financial crisis. It was his understanding that senior British government officials had instructed the bank to alter the rates. Mr. del Missier's testimony followed statements from Diamond in which he denied that he had told his deputies to report false Libor rates. Speaking before Parliament the previous week, Tucker stated that he had shared concerns regarding Barclays Libor rates because the markets might view Barclays to be at risk if its Libor submissions continued to be higher than those of other international banks. In the midst of the Lehman Brothers collapse, there was concern the bank might need to be bailed out if the financial markets perceived it was a credit risk. Tucker told the committee, “I wanted to make sure that Barclays’ day-to-day funding issues didn’t push it over the cliff."

Impact on banking regulation in Europe and the US

US experts such as Former Assistant Secretary of the Treasury Paul Craig Roberts have argued that the Libor Scandal completes the picture of public and private financial institutions manipulating interest rates in order to prop up the prices of bonds and other fixed income instruments, and that “the motives of the Fed, Bank of England, US and UK banks are aligned, their policies mutually reinforcing and beneficial. The Libor fixing is another indication of this collusion." In that perspective they advocate stricter bank regulation, and a profound reform of the Federal Reserve System.

Mainland European scholars have also discussed the necessity of far-reaching banking reforms in light of the current crisis of confidence, recommending the adoption of binding regulations that would go further than the Dodd–Frank Act: notably in France where SFAF and World Pensions Council (WPC) banking experts have argued that, beyond national legislations, such rules should be adopted and implemented within the broader context of separation of powers in European Union law, to put an end to anti-competitive practices akin to exclusive dealing and limit conflicts of interest. This perspective has gained ground after the unraveling of the Libor scandal, with mainstream opinion leaders such as the Financial Times' editorialists calling for the adoption of an EU-wide "Glass–Steagall II".

Citigroup Chairman and CEO Sandy Weill, considered one of the driving forces behind the considerable financial deregulation and “mega-mergers” of the 1990s, surprised financial analysts in Europe and North America by “calling for splitting up the commercial banks from the investment banks. In effect, he says: bring back the Glass-Steagall Act of 1933 which led to half a century, free of financial crises.”

Reactions

In a July 14 editorial in The Guardian, Naomi Wolf suggests that the "notion that the entire global financial system is riddled with systemic fraud – and that key players in the gatekeeper roles, both in finance and in government, including regulatory bodies, know it and choose to quietly sustain this reality — is one that would have only recently seemed like the frenzied hypothesis of tinhat-wearers". Looking at the fact that Tim Geithner went on to be promoted to Treasury Secretary, Wolf commented, "It is very hard, looking at the elaborate edifices of fraud that are emerging across the financial system, to ignore the possibility that this kind of silence – 'the willingness to not rock the boat' — is simply rewarded by promotion to ever higher positions, ever greater authority. If you learn that rate-rigging and regulatory failures are systemic, but stay quiet, well, perhaps you have shown that you are genuinely reliable and deserve membership of the club."

(Source: Wikipedia)