Chairman Ben S. Bernanke defended the Federal Reserve’s response to manipulation of the London interbank offered rate, saying the Fed cooperated with other regulators and suggested a fix.
“The investigations took place, but they were taken up quite quickly by not the Fed, which is a safety and soundness regulator, but by the authorities that had the most direct responsibility for those issues,” Bernanke said in testimony today to the Senate Banking Committee in Washington. The Federal Reserve Bank of New York “took the lead” and “informed all the relevant authorities” in the U.K and U.S.
Regulators in both countries have defended their reaction to the manipulation of Libor, the global benchmark for $500 trillion of securities, after Barclays Plc was fined a record 290 million pounds ($453 million) for rigging borrowing costs.
The New York Fed last week released documents showing it knew Barclays underreported rates and that Timothy F. Geithner, then the president of the regional Fed bank, sent a memo in June 2008 to Bank of England Governor Mervyn King recommending changes to how Libor was calculated.
“What you come away with is ‘Look, we turned it over to the responsible people in Europe -- we did our job,’” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors in Sarasota, Florida. While Fed officials “could have done more,” they are making it “pretty clear that this is the Brits’ problem.”
Geithner, now U.S. Treasury secretary, advised King in the memo to “establish and publish best practices for calculating and reporting rates, including procedures designed to prevent accidental or deliberate misreporting.” He made a total of six suggestions.
King told Parliament’s Treasury Committee today in London that he only knew of wrongdoing two weeks ago and that Geithner’s memo in 2008 didn’t highlight malpractice.
“Mr. Geithner was sending that to us as a suggestion for how these rules should be constructed and we agreed with him, but neither of us had evidence of wrongdoing,” King said. “The first I knew of any alleged wrongdoing was when the reports came out two weeks ago.”
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. Still, misreporting of Libor is “very troubling,” he said.
Bernanke was questioned by lawmakers as to why the central bank didn’t act more aggressively. Senator David Vitter, a Republican from Louisiana, said it appears the New York Fed “reacted on the policy side with various discussions” and recommendations.
“I haven’t seen anything about it reacting as a regulator of large U.S. banks,” Vitter said. “Did it do anything to investigate whether U.S. banks were guilty of the same practice?”
Bernanke said the Fed doesn’t know that U.S. banks are innocent of rate-rigging.
“If we don’t know that, it seems like somebody dropped the ball, the fact that we’re four years later and we don’t know that,” Vitter said.
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.
Geithner’s 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.
“The Libor system is structurally flawed,” Bernanke said in testimony today. “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.
Bernanke said the New York Fed “responded very quickly” and “informed all of the relevant authorities.” The district bank “took the lead here,” while the Fed’s Washington-based board was “in supporting mode,” he said.
The New York Fed released the documents last week 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 charged 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.