Libor Reported as Rigged in ’08 Proving 2012’s Revelation
Barclays Plc’s admission that it rigged the London interbank offered rate shows regulators, central bankers and politicians weren’t paying attention when everyone from Citigroup Inc. to the Bank for International Settlements indicated that the measure was being manipulated.
The BIS signaled in March 2008 that the benchmark was being misstated. A month later, analysts at Citigroup suggested the same. In May of that year, one of Barclays’s own strategists said the numbers reported by banks “were a lie.”
Barclays’s acknowledgement that it submitted false rates during the height of the credit crisis cost Chief Executive Officer Robert Diamond and other top managers their jobs and cut the bank’s market value by about 4.4 billion pounds ($6.9 billion). In the U.K. and abroad, at least a dozen banks are being investigated for manipulating Libor. Mervyn King, the Bank of England Governor since 2003, said this week that he only recently became aware of wrongdoing in the rate published by the British Bankers’ Association.
“The basic underpinning in credit is confidence and trust,” John Lonski, chief economist at Moody’s Capital Markets Group in New York, said in a July 18 telephone interview. “There has to be this trust in other parties if credit is going to work.”
Five years after the onset of the worst financial crisis since the Great Depression, there’s still a lack of oversight of an opaque measure that has rattled markets and further eroded confidence in the financial system. Libor is a benchmark for $500 trillion of worldwide financial products from leveraged derivatives to home mortgages.
At least a dozen banks are being probed by regulators worldwide for potentially rigging the benchmark rate, including Citigroup, Royal Bank of Scotland Group Plc, UBS AG, Lloyds Banking Group Plc and Deutsche Bank AG.
Japan’s banking lobby said this week it may review lenders’ rate submissions and South Korea regulators started a probe into possible collusion in its money markets. Citigroup and UBS were ordered in December by Japanese regulators to suspend some businesses after their bankers were found to have attempted to influence the Tokyo interbank offered rate, or Tibor.
While e-mails from the New York Federal Reserve Bank indicate King must have known that Libor was being misstated, officials had incentive to ignore the rigging as they sought to manage the credit crisis, said Richard Bove, an analyst with Rochdale Securities LLC in Lutz, Florida, with more than 40 years of Wall Street experience.
“If he was unaware, he was ignoring what the president of the Federal Reserve Bank of New York was asking about,” Bove said in a July 18 telephone interview.
Libor is derived from a survey of London banks conducted each day by Thomson Reuters Corp. (TRI) on behalf of the BBA. Bloomberg LP, the parent of Bloomberg News, competes with Thomson Reuters in selling financial and legal information and trading systems.
Lenders are asked how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies including dollars, euros, yen and Swiss francs. After a set number of quotes are excluded, those remaining are averaged and published for each currency by the bankers’ association before noon. The three-month rate in dollars was as set at 0.4531 percent today.
Libor became a closely watched measure in 2008 as a gauge of the health of the financial system as the world’s largest banks were in the midst of taking more than $1 trillion in writedowns and losses on toxic debt stemming from the collapse of the subprime mortgage market in the U.S.
Within a matter of weeks in August 2007, the difference between Libor and three-month Treasury bill rates, a measure called the TED spread, jumped to 2.4 percentage points from less than 0.5 percentage point as banks become wary of lending to each other. In the prior 12 months the gap averaged about 0.38 percentage point. The spread remained elevated through 2008, widening to as much as 4.64 percentage points in October following the collapse of Lehman Brothers Holdings Inc.
It was in March 2008 -- the same month the Fed brokered JPMorgan Chase & Co.’s buyout of Bear Stearns Cos. as bank losses mounted -- that the three-month Libor rate in dollars fell 40 basis points, or 0.40 percentage point, to 2.7 percent even as yields on financial company bonds worldwide climbed almost half a percentage point to 5.86 percent.
While the Basel, Switzerland-based BIS, a type of central bank for central banks, concluded in a March 2008 report that the system of establishing daily short-term interest rates between banks generally worked as intended during the early stages of the credit crisis, its economists said in interviews at the time that there was concern banks were manipulating the fixing process to prevent their borrowing costs from escalating.
Scott Peng, head of U.S. interest-rate strategy at Citigroup’s global markets unit in New York, wrote a research note April 10, 2008, titled “Is Libor Broken?” that brought widespread attention to the possibility that European banks were likely submitting lower-than-actual transacted rates to avoid “being perceived as a weak hand in a fragile market.”
Three-month Libor, 2.71 percent at that time, was likely too low by 20 basis points to 30 basis points, Peng wrote in a report with co-authors Chintan Gandhi and Alexander Tyo. Peng left the bank in 2009.
Libor rates jumped after the BBA said April 16, 2008 that any member banks found to be misquoting rates will be banned from the survey. The cost of borrowing in dollars for three months rose 18 basis points to 2.91 percent in the following two days. The one-month rate climbed 14 basis points, the most since November.
Tim Bond, then head of asset allocation at Barclays Capital, said in May 2008 that banks routinely misstated borrowing costs to avoid the perception they faced difficulty raising funds as the financial system reeled.
“The Libor numbers that banks reported to the BBA were a lie,” Bond said. “They had been all along. The BBA has been trying to investigate them and that’s why banks have started to report the right numbers.”
A survey in June 2008 also suggested that the benchmark was inaccurate. Eighty-two percent of the 106 respondents agreed that Libor didn’t represent actual rates in money markets, according to respondents in an ACI-The Financial Markets Association poll in May 2008.
Of those members noting a discrepancy, 24 percent indicated inconsistencies mainly involved U.S. dollar Libor, which varied 15 basis points to 25 basis points from actual rates.
“Whether or not Mervyn King knew about it, and when he knew about it, is just speculation, but I’ll tell you in the marketplace there were a lot of people aware of what was going on and were somewhat flummoxed,” Andrew Busch, a global currency and public policy strategist at Bank of Montreal in Chicago, said July 17 in a telephone interview. “It seemed something was incorrect.”
A Bank of England spokesman, who didn’t want to be named in line with the institution’s communication policy, referred to the comments by the governor to the Treasury Committee this week and declined to comment further.
King, in his testimony this week, said that a memo from then New York Fed President Timothy F. Geithner in 2008 regarding Libor didn’t highlight malpractice. He told Parliament’s Treasury Committee on July 17 in London that the e- mail included recommendations for Libor rules rather than allegations of manipulation.
Geithner, who is now Secretary of the U.S. Treasury Department, wanted procedures to prevent “misreporting,” and the bankers’ association, which was reviewing Libor at the time, said it would take the recommendations on board.
“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 New York Fed knew “some banks” were potentially understating submissions for Libor as early as 2007, according to a statement posted on its website on July 13. 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 central bank said.
“There were a lot of rumors flying around in 2008,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, which oversees $12 billion in fixed income assets, said July 17 in a telephone interview. “I would also point out that Libor and movements in Libor were a very small piece of a much larger puzzle at the time. You put out the largest fires first.”
Adair Turner, chairman of the Financial Services Authority, was first notified about the Libor investigation in November 2009, when then FSA Chief Executive Officer Hector Sants told him about the case they were working on with the U.S. Commodity Futures Trading Commission.
In testimony to U.K. lawmakers on July 16 Turner said it hadn’t occurred to him before 2009 that the rate was something that could be manipulated. Barclays employees told the FSA about “dislocations” in the benchmark and didn’t say that anyone was submitting false rates, he told the Treasury Select Committee.
The reports only reached the junior level and weren’t escalated to senior management, Turner said. He asked the FSA’s internal audit department to review any contact with Barclays to determine whether the agency missed red flags on Libor.
“This was under-regulated,” George Mudie, a lawmaker from the opposition Labour party, told Turner at the hearing in London. “You were warned about it and warned about it.”
The Commodity Futures Trading Commission, among the regulators that levied the $451 million fine against Barclays, has laid out a hierarchy of transactions or instruments that panel member banks should consider when deciding on what rate to submit in the daily Libor fixing.
Arlene McCarthy, the lawmaker leading work in the European Parliament on draft rules against market abuse, said today the assembly should conduct a full hearing into the Libor scandal.
Fed Chairman Ben S. Bernanke said July 17 in responding to questions during testimony to the Senate Banking Committee in Washington that the Fed was concerned by the underreporting of Libor and had a “substantial response” to address the problem.
Bernanke said the Fed didn’t have information to suggest banks were manipulating rates “for profit,” only that some banks were “possibly submitting low rates to avoid appearing weak” during the financial crisis, he said.
“It’s going to further erode confidence in financial markets and financial instruments,” Bernanke said during his second day of testimony yesterday before the House Financial Services Committee.
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