When The LIBOR is Manipulated You Should Care

I assume you may have heard about the recently breaking Barclays scandal on the LIBOR and many of you may have started to read about it and gotten lost in the economic terms and discussions.  I am going to try to break it down in laymen’s terms but I assure you, either way, it is important that you understand what has happened because in this big wide world what a few bankers did in London, New York etc. could have cost you money at some point and time.  To put it in the simplest terms they used the LIBOR not only to trade at generous terms to Barclays but they also used it to hide their true financial status.

In the forefront right now is Barclays Bank and their manipulation happened in two ways: first, Barclays’ traders attempted to steer rates up or down in order to benefit trades they had made to profit off of those rates. Separately, during the financial crisis, Barclays tried to counter reports that it had financial troubles by changing the interest rate it reported.  So they used it to make money and they also used it to fabricate their balance sheets.  Either way you look at it, you see deception but there is much more that was affected than just their activity

The current LIBOR interest rate scandal, involving hundreds of trillions in international derivatives trade, shows how the really big boys play. These modern international bankers are in a class of thieves unlike even the best that came before them.  The scandal over LIBOR which is short for London Interbank Offered Rate has resulted in a huge fine for Barclays but it also threatens to ensnare some of the world’s top financiers, including banks in our country.  And like I think most of us already assume, it reveals a continuing cesspool of corruption.  Will these guys ever do the time?  Mostly not because they also are in a position to rewrite the laws before they commit the crime.  And what was Barclays defense?  Every institution in their class was doing the same thing, JP Morgan, Citigroup, Chase, among others, are now being investigated.  To give you an idea of the scope of this, they were manipulating the LIBOR rate that is critical to a $700 TRILLION derivatives market, yes $700 trillion.  And now for the explanation of why and how they pulled this one off.

First you should know what these interest rates are and how one bank could manipulate them.  The LIBOR, or London Inter Bank Offered Rate, is a short-term interest rate that is meant to reflect the cost of borrowing between banks.  Banks frequently lend to each other. A panel of banks submits estimates daily to a trade group, the British Bankers’ Association, then Thomson Reuters, parent company of Reuters news,  compiles an average rate for them, discarding any very high or low submissions.  Basically like your credit score where a lender will take the middle number as the most true number. This average rate is used to set rates for financial products, all the way down to consumer loans and mortgages. This same process is done in Europe, Asia and the U.S etc..  It is estimated that those financial products could be worth some $360 trillion on any given day.  (It should be mentioned here that 4 years ago in March 2008, the Wall Street Journal exposed this scandal.  I have been involved in financial investigations and I know they take awhile.  You have to wade through a lot of documentation that while you may be a great investigator, you may not understand all the ramifications of any one entry or act or understand a full disclosure statement.  Perhaps that is why the DOJ has just now fined Barclays and is now investigating the rest.)

So you might ask why did Barclays traders want to mess with the rates?  Because the traders wanted to influence the rates in order to profit on positions they had taken in particular trades and to benefit Barclays’ derivatives portfolio as a whole. Evidence shows that this occurred frequently from 2005 to 2007 and occasionally until 2009. It’s not clear when, and by how much, the traders’ requests actually affected the rates, though the U.S. Justice Department says they sometimes did and the govrnment faults Barclays for not setting controls on how the LIBOR was submitted.  Staff responsible for submitting estimates for LIBOR were asked by traders to go high or low on a certain day and the reward was sharing a bottle of Bollinger with the trader.  Some of the attempts also involved former Barclays traders at other banks.  All the while, like the Chinese Wall at JPMorgan back in 2000-2002, management had to know what was happening but failed to take action.  You can read the full statement of facts here:

http://www.propublica.org/documents/item/394201-barclays-doj-statement-of-facts.html#document/p13/a62601

A lot of attention is being paid to the traders and their scheming but Regulators also point to how Barclays tried to shore up market confidence in the bank’s stability during the financial crisis with the same manipulation.   As the statement of facts detail, in 2007, Barclays started submitting higher estimates for the LIBOR, saying they reflected rocky market conditions. But relative to other banks, which were still submitting low rates, Barclays looked risky. The bank maintains it was hamstrung because other banks were going artificially low. Robert Diamond, Barclays CEO, told a committee of British lawmakers this past week that “A number of banks were posting rates that were significantly below ours that we didn’t think were correct”.  So, according to the regulators in this investigation, Barclays management issued a directive that “Barclays should not be an “outlier,” and that submitters should lower their estimates to bring Barclays “within the pack.”  The sad thing here is Barclays could have been the “GOOD GUY” to many people but they chose to follow the pack.  At one time, in my tenure with Wells Fargo Bank, I met with some bankers from Barclays.  They were looking to set up a Merchant division and were referred to us by Visa USA as one of the better banks in managing merchant accounts.  We were very conservative in our process and these bankers from Barclays had intentions of taking their business on the far side of conservative even from what we were doing.  The only department they agreed with was our Risk Management department that I was involved in showing them.  What a difference a few years makes.

Another repercussion of this practice is regulatory efforts.  By keeping rates low during the financial crisis, the banks were trying to quell concerns about the health of the banking system and “stave off calls for additional regulation.”  It is hard to say who and when investigators took action but again the repeal of Glass Steagal in this country was a major reason why this was able to be undertaken.  That and sloppy regulators at the SEC, The Fed, The Federal Reserve Bank of NY and the CFTC as well as regulators in Britian.  If you read this article from the Desert Beacon, you will get a better understanding of these continued issues with financial institutions but the bottom line is THERE IS NO SELF REGULATION, plain and simple.  The financial institutions will continue on their merry path until someone finally goes to prison.(You may have to scroll down to get to this article)

http://desertbeacon.wordpress.com/2012/07/06/libor-suction-ii-a-lack-of-institutional-control/

And this is a big deal . Remember that JP Morgan scandal a few months back? That was mostly JP Morgan hurting itself. The LIBOR scandal was Barclay’s making money by hurting you.

Donald MacKenzie, a sociology professor at the University of Edinburgh, described the process in the London Review of Books:

The calculation of Libor is coordinated by just two people, who work in an eswhich seemed utterly routine, a couple of years ago. Just after 11 a.m. on every weekday that’s not a bank holiday, traders at leading banks send in their estimates of the interest rates at which their banks could borrow money. They do this electronically, but sometimes the co-ordinators make a phone call to a bank that hasn’t sent in its estimates, and if the latter seem implausible – typos, for example, are fairly common – they’re checked, also with a quick call: ‘Hi there, is the Kiwi chap [provider of the estimates, also with a quick call: ‘Hi there, is the Kiwi chap [provider of the estimates for borrowing New Zealand dollars] about? … Bit of a spread on the two month. Everyone else is coming in a good bit under that.’

A simple computer program discards the lowest quarter and highest quarter of the estimates, and calculates the average of the remainder. The result is that day’s Libor. The calculation is repeated for each of ten currencies and 15 loan durations (from overnight to 12 months), so 150 Libors are published daily: overnight sterling Libor, one-week euro Libor, one-month yen Libor, three-month US dollar Libor and so on.

The next question is why care about these numbers and the answer is simple, $360 trillion in assets worldwide are indexed to LIBOR daily, and a great deal of those assets are consumer debt instruments like mortgages, car loans and credit card loans.  I am sure you now see where this is going.  LIBOR high you pay more for that car, low you pay less.

In the United States, the two biggest indices for adjustable rate mortgages and other consumer debt are the prime rate (that is, the rate banks charge favored or “prime” consumers) and LIBOR, with the latter particularly popular for subprime loans. In 2008 almost 60 percent of prime mortgages and nearly 100 percent of sub-prime mortages were indexed to Libor, according to a study by Mark Schweitzer and Guhan Venkatu at the Cleveland Fed.  So you have to ask yourself did the bankers also modify the LIBOR in order to get the most out of the interest rates you were charged on any given loan?  The answer is more than likely they did.  You simply cannot trust them anymore.  You can read that study here:

http://www.clevelandfed.org/research/commentary/2009/012109.cfm

So this means that when LIBOR rises, so do the prices ordinary consumers pay to get a mortgage. Which means a bank that mucks with the LIBOR rate isn’t just playing around with esoteric derivatives that will only affect other traders: They’re playing with the real economy that most of us participate in every day.

So how did the manipulations by Barclay’s affect this rate?  According to Ezra Klein of the Washington Post this is how:

First, from 2005 and 2007, the bank allegedly varied the rates it reported to the BBA and Thomson Reuters so as to improve its margins on internal trades. For example, it could have placed bets that the LIBOR rate would increase, and then reported artificially high rates which in turn artificially increased the LIBOR averages, so that the bets were likelier to pay off. This not only screwed the investors on the other side of the trade, but bumped up mortgage rates– however infinitesimally – for consumers even when the risk of the loans hadn’t changed at all.

Second, in late 2008 Barclay’s– and, Diamond alleges, other banks – apparently low-balled the rates they reported for LIBOR averaging so as to make the banks’ finances look more stable than they were. The idea was to put out a false image of stability to prevent market panic and stave off calls for additional regulation or even nationalization, a solution that looked increasingly likely during the height of the financial crisis. The direct effect for consumers here was to make loans cheaper, but the indirect effect, or the intended one at least, was to lessen chances of government action against the banks. So the banks manipulating LIBOR weren’t just messing with peoples’ finances – they were trying to mess with the peoples’laws.

The LIBOR scandal, then, is something more insidious than the multi-billion dollar failed trade  that got JPMorgan into so much hot water.  Unlike the assets JPMorgan was trading on, the LIBOR rate has real consequences for average consumers, and its manipulation could hurt your typical mortgage-holder, however minimally.

Further, at least some LIBOR manipulation was an attempt to manipulate government policy by changing the very data that regulators use to make decisions. If the LIBOR games prevented governments from pursuing policies that could have made the financial system more stable, the main victims, again, are ordinary consumers.

http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/07/05/explainer-why-the-libor-scandal-is-a-bigger-deal-than-jpmorgan/

So what other institutions are being investigated?  Revelations about other banks have been trickling out over the past year(from the Washington Post article):

UBS previously made agreements to cooperate with several international investigations in exchange for leniency on potential criminal charges.

Citigroup was also a target of investigation. Earlier this year, revelations emerged that a few traders at Citigroup and UBS tried to manipulate Libor rates for the Yen.

The Times of London has reported that Royal Bank of Scotland could soon be hit with a fine of up to $150 million for related charges.

Bank of America allegedly received a subpoena last year from regulators as part of the investigation. JPMorgan Chase, Credit Suisse, HSBC and others were on the Libor-setting panel during the period being investigated.

Last fall, European regulators seized documents from Deutsche Bank and others regarding manipulation of the Euribor.

Private lawsuits over Libor are already underway. Last summer, Charles Schwab filed a suit alleging anti-trust violations against many Libor-setting banks and at least one class action has been filed alleging that Libor manipulation meant banks paid “unduly low interest rates to investors.”

The sad reality is that they will probably get away with it. The world of high finance is by design as obscure and opaque as the bankers and their political surrogates can make it, and even this most recent crack in their defense of deception will soon be made to go away.  Perhaps that is why the powers that be reacted so strongly to Occupy Wall Street.  OWS was constantly in their face pointing out the egregious behavior of the banks and you know when the “elite” are in the spotlight for anything other than their “good works”, the spotlight gets hotter than they can handle.  The fact that the mayors of cities in their corner sat in on conference calls to determine how to jointly attack these protestors, most likely this made it much easier for Mayor Bloomberg and other Mayors to unleash the “SS of NY” better known as the NYPD and other major cities, but I am just guessing there.

For help cutting through all the jargon, see this helpful explainer from American Public Media.

http://www.marketplace.org/topics/world/easy-street/libor-mortals-easy-explainer