...no executives will suffer so much as a sleepless night over the massive, systemic manipulation of the Libor rate and whatever system is brought in to take its place will be gamed in another way somewhere down the road.
Remember when the biggest financial fraud in the history of the world was uncovered two years ago? You know, the manipulation of LIBOR, the benchmark rate on which as much as $800 trillion (that's TRILLION with a “T”) worth of financial contracts are based? Does any of this ring a bell? No?
That's not surprising. It was swept off the news radar, under the rug, into the dustpan and down the memory hole before you had the chance to even change the channel. “Deliberate rate-rigging at the base of hundreds of trillions of dollars' worth of financial instruments? Pfff, bo-o-ring. Tell me more about Ray Rice!”
Well the latest tidbit has just fallen from the table of the UK's seriously named “Serious Fraud Office (SFO)” in the form of a press release entitled “LIBOR manipulation: banker pleads guilty to conspiracy to defraud.” But don't blink or you might miss it; the entire press release is five sentences long. Here it is in its entirety:
“A senior banker from a leading British bank pleaded guilty at Southwark Crown Court on 3 October 2014 to conspiracy to defraud in connection with manipulating LIBOR. This arises out of the Serious Fraud Office investigations into LIBOR manipulation. Further details cannot be given at this time for legal reasons. This is the first criminal conviction arising from the Serious Fraud Office's LIBOR investigation. 11 other individuals stand charged and await trial. The investigation into others continues.”
If all of this seems a touch low key for the criminal investigation into the largest market manipulation in history, again you are not alone. A single, unnamed banker pleads guilty to a single count of (gasp) conspiracy to defraud after more than two years of investigation and we're supposed to applaud like trained seals?
To be fair, this isn't the only action that's been taken so far on Libor. A consortium of banks including Barclays, UBS, Royal Bank of Scotland, Lloyds Banking Group and others have been charged a total of more than $3 billion for their part in the manipulation of Libor-linked interest rates. The UK's “Financial Conduct Authority” is currently in talks with Deutsche Bank, Citigroup, Bank of America, JP Morgan, Barclays and Bank of New York Mellon over their role in the scandal and is expected to reach settlements totaling in the billions of dollars with these banks in the near future. The SFO still has 11 more individuals it is proceeding with criminal prosecution against and Barclays just settled a case in which they agreed to pay $20 million in compensation toward the plaintiffs in a class-action lawsuit brought by Eurodollar-futures traders who were stung by the rate rigging.
In other words, a lot of money is trading hands and very few are going to jail (if any at all). Or: business as usual on Wall Street and in the City of London.
But first, given the fact that this story has been swept under the rug and consigned to the memory hole, a five-minute crash course / refresher course on Libor is in order.
LIBOR is the “Londing Inter-Bank Offered Rate,” or the estimated rate that the leading London banks would have to pay if borrowing from another bank. As the primary benchmark for short-term interest rates in the world, a staggering number of financial instruments are tied to Libor, both in the financial markets and commercial fields. Forward rate agreements, interest rate swaps, variable rate mortgages, term loans, collateralized debt obligations and a variety of other instruments all use Libor as a reference rate, and as a result it's impossible to tell the total value of the instruments riding on Libor. The rate underpins $300 trillion in instruments by conservative estimates; as much as $800 million by some reckoning. Whatever the case, manipulations of tiny fractions of a percentage point in the Libor rate could cause huge effects downstream in the economy, causing unwitting homeowners, money-market fund managers, bond investors, students and countless others extra financial stress.
The most important word from the entire preceding paragraph is “estimated.” Libor is the “estimated” rate that leading London banks pay for inter-bank borrowing because the number is compiled as the average answer among a panel of banks to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?" The answer to that question is a self-reported figure that does not need to be cross-checked against any real world figures; it is based on honesty and trust. The four high and four low figures are thrown out and the rest are averaged, yielding a mean rate that is then reported as the Libor figure for that particular currency (e.g. USD) in that particular loan period (e.g. overnight).
Did the words “honesty and trust” in that previous paragraph make you titter? It should. As you can imagine, the numbers were manipulated, fudged, finessed and downright made up to suit the whims of banks in general and traders in particular. The pressure to manipulate the rates could come in numerous ways from different places: derivatives traders would often find ways of pressuring those employees who submitted the rates to raise or lower the rate to suit their trading positions; sometimes the traders would fill in for sick or absent employees and submit the rates themselves; Barclays admitted that it lowballed its rates because it feared that its rival banks did the same and they would appear to be in trouble if they were consistently quoting too high rates. The most serious accusation to emerge from the entire scandal was that a 2008 conversation between Bank of England Deputy Governor Paul Tucker and Barclays CEO Bob Diamond left the bank with the impression that they had a blank check to manipulate their rates downward in order to give an overall better impression of the banks' health in the wake of the 2008 crisis.
Perhaps unsurprisingly, the uncovering of the Libor fraud led to the “revelation” of similar fraud and abuse in similarly self-reported benchmark numbers in the banking industry. Last year attention turned to the London gold fix, which sets the benchmark gold price used by gold market players like miners, jewelers and central bankers in a daily phone call involving five major banks that is done in complete secrecy with no oversight. Also coming under scrutiny last year was the WM/Reuters rate, used to provide benchmark foreign exchange rates for major foreign currency players. According to Germany's top regulator, which began releasing results of its own investigation in to the manipulations earlier this year, the currency rate rigging is even worse than the Libor scandal as it involved active collusion by traders in liquid markets in order to fix numbers.
These recent moves on the Libor scandal front beg the question of what actual changes are taking place as a result of the revelation of these manipulations. The answer? Don't worry your pretty little head, the Federal Reserve is working on it. Last month Fed Governor Jerome Powell warned of the chaos of a collapsing Libor system with no alternative measure to put in its place.
“If the publication of LIBOR were to become untenable or if we were to simply 'end LIBOR,' as some have urged, untangling the $150 trillion in outstanding U.S. dollar LIBOR contracts would entail a protracted, expensive, and uncertain process of negotiating amendments to an enormous number of complex documents--a horrible mess and a feast for the legal profession, to be sure. It does not help matters that the hundreds of trillions of dollars' worth of derivatives contracts referencing LIBOR do not, in general, have robust backups in the event that publication of a rate ceases.”
His solution? To encourage the adoption of an alternative rate “based on the U.S. Treasury market or rates based on the secured funding markets that have replaced much of the borrowing banks used to do in the unsecured interbank market.” New York Fed President William Dudley elaborated on this last week, advocating for both a reform of the Libor definition to reflect actual observable funding patterns, and the creation of an alternative rate that excludes bank credit risk altogether. According to Dudley: "This combination, a more robust and resilient LIBOR for transactions that require a reference rate with a bank credit risk component and the development of an alternative reference rate for transactions like interest rate derivatives that don't, will strengthen our financial system and help undo some of the damage caused by earlier transgressions."
At the end of the day, anyone expecting that the Fed wolves are going to set the bankster henhouse in order are defying experience, reality and common sense. As if any more evidence were needed, the recent recordings from within the bowels of the New York Fed released by whistleblower Carmen Segerra have already proven that the Fed is completely uninterested in “regulating” any of the banks under its supervision. And the Libor wrist slaps from the SFO are beginning to look like echoes of the DOJ's new push to “attack the big banks” by throwing a few low level dealers under the bus.
Bottom line: no executives will suffer so much as a sleepless night over the massive, systemic manipulation of the Libor rate (or the gold fix, or the foreign currency exchange rates...) and whatever system is brought in to take its place will be gamed in another way somewhere down the road.
If there are any bright spots for the average borrower or investor, it's that a number of class action lawsuits are in progress seeking to recoup money illegally lost by homeowners, student debt holders, bond investors and others who were being unknowingly swindled by the Libor manipulation. It would be a good idea to see what cases are in motion in your jurisdiction and if you are eligible to join in on the suits.