Federal Reserve Chairman Ben S. Bernanke said the underreporting of London interbank offered rates is “unacceptable behavior” and the U.S. central bank offered a “substantial response” to address the problem.
The disclosures are “not only very troubling in themselves but they have the effect of undermining public confidence in financial markets,” Bernanke said during testimony today to the Senate Banking Committee in Washington.
The Fed didn’t have information to suggest that banks were manipulating rates “for profit,” only that some were “possibly submitting low rates to avoid appearing weak” during the financial crisis, Bernanke said. The Fed doesn’t know that U.S. banks are innocent of rate-rigging, and the Federal Reserve Bank of New York is still looking into the situation, he said.
The U.S. central bank is drawing more scrutiny from lawmakers critical of its record as a bank regulator after the New York Fed released documents showing it was aware that Barclays Plc underreported borrowing costs in 2008. Barclays was fined a record 290 million pounds ($452 million) last month and the scandal cost Chief Executive Officer Robert Diamond his job. At least a dozen banks are being investigated.
The New York Fed knew “some banks” were potentially understating submissions for Libor as early as 2007, according to a statement posted on its website last week. A Barclays employee told a New York Fed staff member in April 2008 that the U.K.’s second-largest lender was underreporting its rate to avoid a “stigma,” the Fed district bank said.
In June 2008, then-New York Fed President Timothy F. Geithner sent a memo to Bank of England Governor Mervyn King recommending changes to the way rates are calculated on Libor, the global benchmark for $500 trillion of securities. Geithner is now Treasury secretary. Among his six suggestions was to “establish and publish best practices for calculating and reporting rates, including procedures designed to prevent accidental or deliberate misreporting.”
The proposals were passed along to the British Bankers’ Association by King and Paul Tucker, at the time markets director of the U.K. central bank, according to correspondence released by the Bank of England.
“It is clear that beyond these disclosures that the Libor system is structurally flawed,” Bernanke said. “It is a major problem for our financial system and for the confidence in the financial system, and we need to address it.”
An “international effort” is needed to fix the Libor problem, and potential changes could include increasing the “visibility” to lower the ability of individual banks or traders to affect the rate, he said. Switching to an “observable market rate” may also help, though Libor is “very deeply ingrained in many contracts” so that change may be difficult, he said.
Bernanke said the New York Fed “responded very quickly” and “informed all of the relevant authorities.” The New York Fed “took the lead here,” while the Fed’s Washington-based board was “in supporting mode,” he said.
The New York Fed released the documents in response to a request from Representative Randy Neugebauer, a Texas Republican who serves on the House Financial Services Committee, for transcripts of communications with Barclays relating to setting Libor from August 2007 to November 2009.
Libor is calculated from a daily survey carried out for the British Bankers’ Association, in which the world’s biggest lenders are asked the rate they’re charging to borrow over a variety of short-term maturities in currencies including dollars, euros and yen. Banks have been accused of low-balling submissions for the benchmark during the financial crisis.