Mark Calabria at the Cato Institute usually isn’t shy about criticizing Timothy F. Geithner. Yet he says it was ultimately up to the British to deal with the manipulation of Libor, as only three of the 18 banks that set the London interbank offered rate are based in the U.S.
Geithner was president of the Federal Reserve Bank of New York in 2008 when he learned about banks underreporting Libor, the global benchmark for $500 trillion of securities. He sent a memo in June of that year to Bank of England Governor Mervyn King raising concerns and recommending changes in how the rate is calculated. Little has been done to address the issue since, and King said last month that he only just learned of wrongdoing and Geithner didn’t highlight malpractice.
“Geithner is not the primary person in the world responsible for Libor,” said Calabria, Cato’s director of financial-regulation studies in Washington and a former Senate Banking Committee aide. “There were items on that memo that were absolutely first and last the responsibility of the British Bankers’ Association and by extension the Bank of England.”
Four years after Geithner sent his recommendations, Barclays Plc was fined a record 290 million pounds ($453 million) for rigging borrowing costs, and regulators in both countries have defended their reaction to the manipulation. The failure to work together across jurisdictions highlights the need for better collaboration among policy makers and regulators worldwide, said Kevin Hassett, a director of economic policy studies at the American Enterprise Institute in Washington.
“Coordination between central banks is essential,” said Hassett, a former Fed economist. “We’re at this moment where Europe is very close to a banking crisis that will be made much worse if there’s this view that international central bankers don’t have a clue and don’t communicate well with each other.”
Libor is determined by a daily poll carried out on behalf of the BBA that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies. The scandal cost Barclays Chief Executive Officer Robert Diamond his job, and at least a dozen other banks, including Royal Bank of Scotland Group Plc and Bank of America Corp., are being investigated.
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.”
“We brought those concerns to their attention and we felt, and I still believe this, that it was really going to be on them to take responsibility for fixing this,” Geithner told the House Financial Services Committee in Washington on July 25. He also said he raised concerns to other U.S. regulators, including the Securities and Exchange Commission and the Commodity Futures Trading Commission.
While British authorities have jurisdiction over Libor, Geithner’s response to the manipulation still has fueled criticism that he didn’t act forcefully enough to stop crime and protect markets.
The New York Fed released documents on July 13 in response to a request from Representative Randy Neugebauer, a Republican from Texas, showing it was aware Barclays underreported Libor rates in 2008. Neugebauer asked for more on July 23, covering all communications from August 2007 until July of this year between employees at the New York Fed and banks involved in setting the rate.
‘Here Was Fraud’
“If they were having structural problems, I thought your e-mail was appropriate, but what was being disclosed here was fraud; this rate was being manipulated,” he said at the July 25 hearing, referring to the released material.
During the hearing, Representative Jeb Hensarling, a Texas Republican, said it appeared Geithner treated the Libor concerns “almost as a curiosity or something akin to jaywalking, as opposed to highway robbery.”
Calabria said Geithner should have investigated the internal controls at the banks he was in charge of overseeing -- New York-based JPMorgan Chase & Co. and Citigroup Inc. -- to regulate “by example,” even if the bulk of Libor-setting institutions are based overseas.
Criticism of the Fed’s reaction probably will continue, said Hassett, a former Bloomberg News columnist.
Libor “is going to turn out to be a very large issue, and the fact that Geithner is saying he did everything he could to address the problem suggests that the Fed was asleep at the wheel while there was bad stuff going on,” he said.
The Bank of England initially became embroiled in the scandal over an October 2008 phone call between Diamond and Paul Tucker, at the time markets director of the U.K. central bank. A memo Diamond wrote about the call suggested Tucker might have hinted Barclays could lowball its Libor submissions.
The Bank of England has defended itself by saying that it thought the system was dysfunctional rather than dishonest and that it lacked the powers to make changes.
The Libor scandal has thrown into question Prime Minister David Cameron’s plan to put the Bank of England in primary charge of banking regulation. In 2010, Chancellor of the Exchequer George Osborne announced that he wanted to abolish the Financial Services Authority, the watchdog set up in 1997 by the previous government, and give most of its powers to the central bank.
King told Parliament’s Treasury Committee July 17 in London that Geithner’s e-mail included recommendations rather than allegations at a time when global regulators were expressing concern about the quality of the borrowing benchmark.
“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 BBA reassessed its processes for setting Libor in 2008. E-mails released in July showed that Bank of England officials refused to be associated publicly with the review because it didn’t make deep enough changes to the structure of governance for the rate.
“One of the important points revealed by this episode is that the coordination is very faulty and influenced strongly by regulators defending their own turf and their own financial centers,” said Richard Portes, president of the Centre for Economic Policy Research in London. The U.K. regards Libor’s use across the globe as “one of the signs of London’s financial-sector preeminence.”
Dan Doctoroff, chief executive officer of Bloomberg LP, proposed an alternative to Libor, dubbed the Bloomberg Interbank Offered Rate, in a Wall Street Journal opinion piece this month. Bloomberg LP is the parent of Bloomberg News.
One reason the Fed may have been loath to be more forceful in its direction to the Bank of England is a culture of deference to jurisdiction, Calabria said.
“There’s a reluctance” among central banks, “at least among the top tier,” to criticize the behavior of peers “because I don’t want you to criticize me,’” Calabria said.
When Fed Chairman Ben S. Bernanke’s second round of asset purchases, announced in 2010, sparked complaints around the world that he risked a surge in inflation, current and former central bankers including Bank of Israel Governor Stanley Fischer and former Bank of England policy maker David Blanchflower voiced support. Blanchflower is a Bloomberg Television contributing editor.
On matters of regulation and financial soundness, officials must improve their coordination across borders to strengthen the global financial system, New York Fed President William C. Dudley repeatedly has said.
What’s needed are international guidelines for so-called central counterparty clearinghouses that would back standardized, over-the-counter derivatives trading worldwide, he said in May. Resolution regimes also must be developed for systemically important financial institutions that operate across borders, he added.
Poor coordination may lead to a “race to the bottom” as some officials may focus on what’s best for their institutions instead of overall financial stability, Dudley said in September.
It’s “very discouraging,” Portes said. “The way banks are playing regulators off against each other over the Volcker rule is a good example of why things aren’t going very well.”
The U.S. has faced resistance from foreign governments about its proposed ban on proprietary trading. The regulation, named for former Fed Chairman Paul Volcker, was included in the Dodd-Frank financial regulatory act to restrict risky trades at banks that operate with federal guarantees.
Central bankers and regulators from around the world have voiced concern that the rule, which would apply to U.S. operations of foreign banks, also may extend to activities outside the country. While U.S. government securities aren’t included in the proprietary trading ban, foreign securities didn’t receive an exemption. The Treasury Department and regulators received more than 17,000 comment letters, including from Canada, the European Union, France and Japan.
“One of the things we’ve learned is the lowest common denominator causes the problem,” Hassett said. “That’s a serious cause of concern as the European crisis proceeds.”