In case it isn’t yet apparent to you, the unfolding scandal over manipulation of Libor and its Euro counterpart Euribor is a huge deal. Even though at this point, only Barclays, the UK bank that was first to settle, is in the hot lights, at least 16 other major financial players, which means pretty much everybody, is implicated.
First, Libor is the basis for pricing over $10 trillion of loans. As the CTFC noted:
US dollar Libor is the basis for the settlement of the three-month Eurodollar futures contract traded on the Chicago Mercantile Exchange, which had a traded volume in 2011 with a notional value exceeding $564 trillion.
The Wall Street Journal puts total in contracts affected at $800 trillion.
Second is that price fixing is a criminal violation under the Sherman antitrust act. The Department of Justice stressed that Barclays had been the first bank to cooperate with the investigation and had been extremely forthcoming, and for that reason it would not be prosecuted if it complied with the settlement terms for two years. The implication is that the DoJ will not be as generous with other banks involved in the price-fixing scheme. This is an overview from the Financial Times of Barclay’s misdeeds:
The bank admitted that it lowballed estimates of its borrowing costs from late 2007 to May 2009 because it wanted to reassure investors of its strength during the financial crisis and it believed other banks were doing the same. It also admitted that its traders improperly influenced the rate submissions from 2005 to 2008 to make money on derivatives.
Note that, according to Barclays, there were two scandals: one is the usual “rogue traders” sort, which took place from 2005 to 2007 (funny how these CEOs take credit for overall performance for bonus purposes and blame inadequately supervised lower level employees whenever real trouble arises?); the second, as we will discuss, is that Barclays submitted lower rates for the daily Libor “fixing” than its actual funding costs to make itself look healthier than it was during the crisis. Readers in comments at the time were reporting that published Libor was 30 to 40 basis points below where they found the market to be. Since lawsuits are being launched against Barclays, we will likely see estimates of the impact of the manipulation.
This is Diamond’s defense explanation of the 2005-2007 Libor manipulation:
Barclays traders attempted to influence the bank’s submissions in order to try to benefit their own desks’ trading position. This is, of course, wholly inappropriate behaviour. Barclays submissions should reflect the cost of interbank borrowing rather than individual traders’ positions. The interventions in question were typically on the short term one and three month rates relevant to the wholesale markets and not the longer term rates used to set, for example, retail mortgages. It is also important to note that these traders had no way of knowing whether or not their actions would ultimately benefit or detriment Barclays overall. They were operating purely for their own benefit.
This inappropriate conduct was limited to a small number of people relative to the size of Barclays trading operations, and the authorities found no evidence that anyone more senior than the immediate desk supervisors was aware of the requests by traders, at the time that they were made.
“Immediate desk supervisors” sounds pretty junior to the layperson, but desk heads are often managing directors. It will be interesting to see if they are as low-level as Diamond implies.
This revelation has led to an explosion of harshly critical media coverage in the UK, as well as stern comments from regulators and Labor party members. Jonathan Weil called it “The Golden Age of Financial Journalism, British Edition” and itemized some of the raft of accounts. The Guardian quotes Mervyn King, Governor of the Bank of England:
It is time to do something about the banking system…Many people in the banking industry are hardworking and feel badly let down by some of their colleagues and leaders. It goes to the culture and the structure of banks: the excessive compensation, the shoddy treatment of customers, the deceitful manipulation of a key interest rate, and today, news of yet another mis-selling scandal.
Could you imagine Ben Bernanke saying that? And consider this remark from a Guardian article by Will Hutton:
Investment banking is an organised scam masquerading as a business. It is defined by endemic conflicts of interest, systemic amoral behaviour and extreme avarice. Many of its senior figures should be serving prison sentences or disgraced – and would have been if British regulators had been weaned off the doctrine of “light touch” regulation earlier and if the Serious Fraud Office’s budget had not been emasculated by Mr Osborne. It is a tax on wealth generation and an enemy of honest endeavour – the beast that is devouring British capitalism.
It’s been remarkably difficult to find that sort of blunt assessment in our mainstream media, even though the US was the incubator of the subprime RMBS and CDOs that brought the global economy to its knees.
A first bank executive head has rolled, something we have also not seen in the US except by failure or acquisition. The Barclay’s chairman Marcus Agius is expected to resign on Monday (update: it’s now official).
The content of the official documents have led to further revelations. The FSA remarks had a coded reference to conversations between the Bank of England and Barclays about their Libor submissions and market perceptions. Robert Peston at the BBC broke the story that it was Bob Diamond, then head of Barclays investment bank, now its CEO, who spoke with Paul Tucker, deputy governor of the Bank of England in the fall of 2008. Per Peston:
The heart of the matter is that in 2008, at the height of the credit crunch, the perception of banks’ financial strength was linked to how much they had to pay to borrow. Barclays managers were very worried that the appearance of the bank paying more to borrow than other banks was damaging confidence in its health.
So Barclays so-called “submitters”, the managers who gave borrowing data to the British Bankers Association’s Libor-setting committees, consistently told these committees that Barclays was paying a lower interest rate to borrow than was actually the case.
What is striking is that even the artificially suppressed quotes for Barclays’ borrowing costs provided to the BBA committee were higher than other banks’ quotes.
After the conversation, Barclays management gave an explicit instruction to lower the Libor submissions. The bone of contention is that neither Tucker nor Diamond have records of the conversation. Diamond conveniently recalls that he got the Bank of England’s blessing to lower the bids; Tucker apparently says no. (Note that even if the central bank did consent to the manipulation in October 2008, Barclays had been manipulating Libor actively in 2005 to 2007).
The Libor scandal has escalated into a political row, with Labor demanding a full bore, year-long inquiry into bank pay and culture (!) as well as a criminal investigation of Barclays. The conservative prime minister Cameron instead plans a narrower, independent review of the Libor bid rigging.
The Barclays Libor manipulation looks is on the verge of busting out into a full-bore News Corp. level scandal, the sort of eruption that leads to lasting changes in the political landscape. This Wednesday, Diamond is testifying before Parliament; that is almost certain to escalate the controversy. The British financial media continues to chip away at the story, with further accounts over the weekend. From the Financial Times, which started reporting on this five years ago and persisted despite years of denials by the banks:
Bankers, traders and investors complained to US and UK central banks and regulators that false information was being supplied for the setting of a critical London lending rate as early as 2007.
But only the Commodity Futures Trading Commission, the US regulator, jumped on the issue and started demanding information about the setting of Libor, the London interbank offered rate, which is the benchmark for $360tn in mortgages, credit cards and other contracts worldwide.
The CFTC started investigating in May 2008. It was contacted by a whistleblower, and by spring 2010 it had enlisted the UK Financial Services Authority with strong evidence of attempted manipulation.
The Independent reports that senior Conservative party members may have been involved in the five year coverup of the Libor manipulation:
The Independent on Sunday has learnt that the Conservative deputy chairman, Michael Fallon, is a board member of a leading brokerage firm that dominates the rates market and which has been asked to co-operate with the Financial Services Authority’s investigation into malpractice across the City.
Mr Fallon is a close ally of David Cameron and a senior member of the Treasury select committee that will question the Barclays chief executive, Bob Diamond, this week, prompting demands from Labour that he should declare an interest. The Prime Minister continues to resist calls from Ed Miliband for a Leveson-style inquiry into rate-fixing…
The IoS can also reveal that the Bank of England was aware of concerns over Libor five years ago, and discussed it in at least two meetings with representatives of some of the City’s biggest financial institutions.
And the Telegraph features a bank staffer who was not at Barclays describing how open the price manipulation was during the crisis:
It was during a weekly economic briefing at the bank in early 2008 that I first heard the phrase. A sterling swaps trader told the assembled economists and managers that “Libor was dislocated with itself”. It sounded so nonsensical that, at first, it just confused everyone, and provoked a little laughter.
Before long, though, I was drawing up presentations to explain the “dislocation of Libor from itself” for corporate relationship managers. I was deciphering the subject in emails, internally and externally. And I was using the phrase myself openly with customers of the bank.
What I was explaining was that the bank was manipulating Libor. Only I didn’t see it like that at the time.
What the trader told us was that the bank could not be seen to be borrowing at high rates, so we were putting in low Libor submissions, the same as everyone. How could we do that? Easy. The British Bankers’ Association, which compiled Libor, asked for a rate submission but there were no checks. The trader said there was a general acceptance that you lowered the price a few basis points each day.
According to the trader, “everyone knew” and “everyone was doing it”. There was no implication of illegality. After all, there were 20 to 30 people in the room – from management to economists, structuring teams to salespeople – and more on the teleconference dial-in from across the country…
The main business of the day was to deal with the deepening crisis. And questions were raised about what we, in one of the bank’s sales teams, could be doing to earn our wages….
As part of that, we had to explain the “dislocation of Libor from itself”. As the trader put it, everyone knew that we couldn’t borrow at Libor, you only needed to look at the price of our credit default swaps – effectively survival insurance for the bank – to see that.
What that meant was that even though Libor may have been, for example 2pc, the real Libor rate the bank was paying was more like 5pc or 6pc. So in fact, we needed to be lending money at Libor plus 3pc or 4pc just to break even. That is what we were telling clients.
Now we are seeing some signs in the US of an increased focus on the parasitic nature of big finance in the US media, of recognizing that particular abuses are part of a much larger pattern. This may merely be a coincidence of timing, but look at this section of a Bloomberg op ed by Virginia Postrel (hat tip reader John L):
Lord knows we’ve had more than enough scandals ginned up by Wall Street over the years, and the message that banking executives proclaim after each is: “Don’t worry, we’ve learned that lesson, and it will never happen again.”…
We are told repeatedly that when Wall Street’s deeply flawed incentive system leads to one bad outcome after another, year after year, it will never happen again. Yet it does. And you can add this vital business to the list: The way state and local government officials hire Wall Street firms to raise the billions of dollars their municipalities need to build schools, hospitals, airports and sewers, and provide other essential services.
For some reason, Wall Street never seems to get the message that bribing government officials — and paying each other off — to get access to lucrative municipal-bond underwriting business is illegal. Wall Street has never learned this lesson because the miniscule price it ends up having to pay for misbehaving has absolutely no deterrent value whatsoever.
Indeed, what the cartel of the major banks does over and over again to win underwriting business from local government officials, and the way the cartel then sorts out among itself who gets what fees, is a microcosm of a much wider problem of the increasing power that the Wall Street survivors of the financial crisis have over the rest of us.
But even if US banks have been as deeply involved in Libor manipulation, it’s very unlikely that we’ll see anything remotely like caustic the UK press coverage here. The first reason is many MSM journalists went to the same schools as top bankers, and are reluctant to see members of their class as crooks (this is a long-standing problem, see Kathryn Olmstead’s “Challenging the Secret Government,” which describes how quickly the media retreated from enterprising investigations after Watergate). This has been exacerbated at some institutions by the personal affiliations of top executives. Michael Thomas has argued that the beginning of the end of the New York Times occurred when when Punch Sulzberger joined the board of the Metropolitan Museum: “It meant he would be dining with people he should be dining on.”
By contrast, there seems to be less identification between journalists and leaders in business in government in the UK. Martin Wolf of the Financial Times, speaking at a financial journalism conference at Columbia, remarked that British journalists didn’t see themselves as having a loft role, unlike their American counterparts. But he said that he (and by extension other journalists) assumed top executives and pols were dishonest. That sort of native skepticism seems to have been bred out of the US press.
Second is corporations and government officials play the access journalism game adeptly and journalists are afraid of being cut out of the favors that are doled out to friendly reporters, namely, exclusive interviews and leaks.
But I think the biggest culprit is our political duopoly. The Labor party in England really does represent different interests than the Tories, and is willing to go after the Tories and their allies in a much more persistent manner than our Dems, who ultimately depend on the same funding sources as Republicans. In England, as the News International scandal showed, there is the possibility of real amplification: of media discoveries being fed into political investigations, which in turn lead to more media ferreting. The fact that someone who seemed to have such a lock on power as Rupert Murdoch could be cut down is no doubt a bracing message to the British press, that they have infuence that for the most part they have failed to exercise effectively. So, ironically, a country where banking is a much larger percentage of GDP than the US may be the one where banking misconduct is finally unearthed and at least some of the perps suffer. And that would show our own officials’ failure to act to be the disgrace that it is.