Barclays Bank has today been fined a combined £290M by regulators in the USA, UK and EU for manipulating the LIBOR; an acronym which stands for “London Interbank Offered Rate”. If you think this doesn’t sound sexy, you’re right. But if you think it isn’t critically important and one of the worst scandals to be exposed from the GFC so far, you’re wrong. The LIBOR is meant to be an objectively-set interest rate. It is used as the reference rate for an estimate $350 trillion in derivatives, not to mention an unknowable number of mortgages, international loans and financing arrangements. Many GFC scandals have involved institutions and hedge funds swindling each other out of paper wealth which never really existed. This one has involved one or more banks ripping off any number of governments, businesses, pensions funds and homeowners, and the fines so far are only the precursor to civil lawsuits and further criminal investigations.
Let’s take it from the top. The LIBOR was invented in 1984 as a way of setting a reference interest rate to reflect market conditions which did not depend on the whim of any particular bank or currency. It is based on various categories of financial data in 10 currencies supplied daily by up to 20 banks to number crunchers at Thomson Reuters, who plug the numbers into the algorithm and spit out the official LIBOR each day between 11am and 12pm London time. A similar rate called the EURIBOR is calculated by the European Banking Federation, and Barclays was fined for manipulating that as well, but in the interests of being succinct I will only refer to the LIBOR here.
The most basic way the LIBOR is used is for a financial instrument with variable interest rates to set that interest rate as “LIBOR + 5%” or “LIBOR + 2%” (naturally, financiers have far more complicated formulas than that, but the use of the LIBOR as the starting number is a constant). A financial instrument could be a mortgage, or the loan to your bank which your bank then calculates its variable rate mortgages on, or the interest rate swap that your bank uses to hedge against exchange rate movements… as I said above, it’s very widely used and there are an estimated $350 trillion in derivatives alone which rely on LIBOR.
As for how a bank could gain from manipulating the LIBOR… well, in 2009 Citibank reported that a 0.25% drop in LIBOR would make $936 million for Citibank, while a 0.25% rise would lose Citibank the corresponding amount. That’s incentive. And not just incentive for a rogue trader, but for an entire bank. Or multiple such banks.
“Even taking account of the abnormal market conditions at the height of the financial crisis, and that the motivation was to protect the bank not to influence the ultimate rate, I accept that the decision to lower submissions was wrong” – Barclays CEO Bob Diamond to the UK Treasury Select Committee (“submissions” refers to the data provided by Barclays to the calculators at Thomson Reuters; effectively, the data was altered so as to encourage the LIBOR to be reduced, protecting Barclays from losses at a point of the GFC it could least afford to take them). Since protecting the bank required that the rate be reduced, of course the motivation was to influence the ultimate rate, but one expects this kind of doublespeak from bankers.
It is startling that a major bank CEO would admit to such a major fraud on the global economy, although given some of the emails that have been published in the newspapers it might have been a bit difficult for him not to admit it. Manipulating the LIBOR, it seems, was something the bankers felt perfectly at ease discussing in emails to each other and which, their emails revealed, they had been doing for several years before the financial crisis with profits and not self-defense as the only motive. Obviously they were extremely well regulated and there is no need for any additional oversight of the banking system to ensure it isn’t ripping us all off. Why, Bob Diamond has announced that he will forgo his bonus this year! Surely no more punishment than that is required?
Barclays is only the tip of the iceberg. If you have been wondering how the data from just one bank could tip the LIBOR significantly, award yourself a gold star. It is public knowledge that another 20 or so banks are being investigated by regulators in the US, UK, Europe and Asia for doing exactly the same thing as Barclays, and former traders are already getting their side of the story out before they can have the blame pinned on them. Tan Chi Min, a former senior trader for Royal Bank of Scotland in Singapore, has reportedly alleged in a deposition in a US class action filed against 16 banks that RBS managed “condoned collusion” between the LIBOR staff and the traders to tilt the LIBOR in the direction that best suited the bank’s trading profits. Court papers in the class action also quote a Canadian source described only as “Trader A” who refers to speaking to contacts at RBS, HSBC, Deutsche Bank, JPMorgan and Citibank regarding their LIBOR submissions. The one thing all these contacts apparently had in common (including Trader A) is that they were ex-Barclays.
Barclays may have been the start of it all, but it’s pretty clear it wasn’t the end. Stay tuned.
(Picture via Wikipedia)
