Gaming the System

“If there is any message of the last few years, it’s that banks and bankers simply cannot be trusted.”

— Tim Price, Asset Manager at PFP Group LLP

More than a dozen of the world’s top banks are currently being investigated for manipulating the London Interbank Offered Rate or LIBOR which is used to set interest rates on more than $360 trillion of securities, including mortgages, student loans, credit cards, and swaps.  So far, Barclays is the only bank to be fined ($453 million), but the probe is rapidly expanding meaning there will be more penalties to come. What the banks on the 16-member Libor panel are alleged to have done, is submit artificially low figures to keep the Libor rate down. The figures they submit are supposed to reflect their actual costs when borrowing from other leading banks. Many of them did not do that. They fudged the numbers to make it look like they were in better financial condition than they really were or to maximize their profits on derivative trades. By rigging rates, the banks defrauded investors out of tens of billions of dollars and grossly distorted the markets. Under the Sherman Antitrust Act, price fixing is a criminal offense. Someone needs to go to jail.

As of today, there are no reliable estimates of how much investors, mortgage holders, swaps traders etc may have lost by the rigging, although this back-of-the-envelope rundown by the Wall Street Journal is helpful:

“If dollar Libor is understated as much as the Journal’s analysis suggests, it would represent a roughly $45 billion break on interest payments for homeowners, companies and investors over the first four months of this year.”

Since the manipulation persisted for many years, it is reasonable to assume that the amount lost probably exceeds many hundreds of billions of dollars. Now take a look at this from Bloomberg:

“On Sept 13, 2006, a senior Barclays trader in New York e-mailed the person who submitted the rate, “Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help,” according to a CFTC document.”

Sounds a lot like the Enron tapes, doesn’t it, where traders were caught chuckling about how they had just ripped off “Grandma Millie.” It’s the same here, only worse. Since Libor is pegged to $360 trillion in securities and contracts, every bogus submission must have resulted in hefty losses for someone else.

And notice how casually the Barclay’s trader makes his request to “fix the rate at 5.39 for the next few days”? That doesn’t sound like someone who’s afraid that regulators are going
to swoop down and cart him off to the pokey for 20 years or so, does it? No, it sounds like someone who does this quite often, maybe daily. It’s all just “part of the job”. That suggests that the corruption is deep-rooted,  pervasive and goes straight to the top. This isn’t just a few bad apples. The whole system’s gone haywire. Here’s a clip from the International Financing Review:

“The FSA report also shows that, between January 2005 and May 2009, around 200 requests were made to Barclays’ submitters for US dollar and yen Libor as well as Euribor by at least 14 derivatives traders. More than 30 of those requests were based on communication from outside traders, and numerous attempts were made to influence submissions from other banks.”

So, what’s going on here? Were traders just dialing up Barclays and putting in their orders for a particular rate? Keep in mind, the banks are obligated to submit the rate that reflects their own borrowing costs, not  the rate that makes their trading desk the most money. And there’s another thing, too. It makes no sense for a trader to request a particular rate, unless the other banks on the 16-member panel are on board. After all, all 16 members make their submissions daily, but then the 4 highest and the 4 lowest submissions are discarded to avoid collusion. That leaves the 8 remaining submissions, the average of which becomes the daily rate. So if the banks were rigging the rate, there must have been widespread collusion. And, apparently, there was, at least according to an anonymous trader from one of Britain’s largest lenders. In an interview with the Telegraph, the trader said that the manipulation was so commonplace that,

“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…..  Everyone knew and everyone was doing it”.

Because Libor is so critical to the functioning of global financial markets, security is quite tight. Here’s a clip from an article in the London Review of Books:

“The co-ordinators have dedicated phone lines laid into their homes so they can still work if a terrorist attack or other incident stops them reaching the office. A similarly equipped building, near the office, is kept in constant readiness, and there’s a permanently staffed back-up site in a small town around 150 miles from London. Its employees periodically work in the London office, so that they’re ready to take over if need be.

The precautions are necessary because if Libor suddenly became unavailable, large parts of the global financial system would be paralysed. The 150 numbers constitute the dominant global benchmark for interest rates. The rates on borrowing, amounting to around $10 trillion (corporate loans, adjustable-rate mortgages, private student loans and so on), are pegged to Libor. For instance, the level of Libor determines the monthly payments on around half of the adjustable-rate mortgages in the US: rates are set as Libor plus a fixed margin, and are reset periodically as Libor changes.”

As it turns out, it’s not “a terrorist attack” people should be worried about, but the banks themselves who have now admitted to rigging the system for their own gain. In fact, its’ even worse than it sounds. According to the Financial Times:

“lower level Barclays’ officials “believed mistakenly that they were operating under an instruction from the Bank of England (as conveyed by senior management) to reduce Barclays’ Libor submissions”, according to the UK Financial Services Authority’s description of what happened.

Although the individuals are not identified in the documents, three people familiar with the contents confirmed that they are Mr Diamond and Mr Tucker, who heads the BoE’s financial stability arm.”

So Barclay’s CEO, Bob Diamond, believed that Paul Tucker, (Deputy governor of the Bank of England) had given him his blessing to submit bogus estimates of what it would cost Barclay’s to borrow money from other banks? Why? To bamboozle investors into thinking the system was solvent?

Well, if the Deputy governor of the Bank of England was involved in the swindle, then what about the Prime Minister? Was he in on it, too? How high does this go? This is from The Guardian:

“The focus now is on who participated in the collusion. Last May Canada’s Competition Bureau filed an affidavit against a number of banks, including HSBC Bank Canada, and Royal Bank of Scotland NV, demanding staff hand over emails and other documents.

Bureau investigators want to determine whether the banks conspired to fix derivative interest rates, a major form of market manipulation. According to the affidavit, one bank which has turned whistleblower and agreed to help the Canadian authorities with its investigation, the banks “communicated with each other… to form agreements…” which “was done for the purpose of benefiting trading positions”.

One trader at the whistleblower bank is alleged to have communicated with traders at HSBC, Deutsche Bank, RBS, JP Morgan and Citibank.

The crucial question is whether the traders were acting on their own or were doing so with the backing, or at the very least, the knowledge of senior managers. Certainly there are allegations senior management at at least one bank was aware what was happening.

A lawsuit filed in Singapore by a former RBS trader, fired by the bank, alleges it was “common practice” among RBS’s senior employees to make requests for the Libor submissions to be set at certain rates. RBS rejects the claim.

Barclays too denies that senior management were aware of what was happening on the trading desks. Diamond accepts only that a “small number” of Barclays’ traders were aware of efforts to rig a series of short-term interest rates to benefit their own desks’ trading positions.”

So, the rate fixing wasn’t just to make the banks look financially stronger then they really were. It was also to “benefit trading positions.” In other words, this wasn’t just an emergency measure to preserve the integrity of the banking system during a period of crisis. It was also to rake in record profits on derivatives contracts and credit swaps. Is it any wonder why one analyst said the allegations “confirm the prejudices of even the most hysterical anti-banking zealot”?

Indeed, it makes banking look like a vast criminal operation run by racketeers.  And the notion that no “senior managers” were involved is laughable. What rookie trader would risk his career by fiddling the bank’s Libor submissions by himself? That’s nonsense. What would he gain by that; a pink slip and directions to the unemployment office? The idea is ridiculous.

Obviously, the CEO and the bigwigs in the front office were involved. They’re the only one’s who really had a motive, which was to make the bank look like it was in better financial condition than it really was and to boost profits. That’s why it was “common practice”, which is the same as saying that it was company policy. Isn’t that what it amounts to? The bank was making money by cheating.

The Libor story goes way back to May 2008, when the Wall Street Journal discovered discrepancies between Libor rates (which had been falling) and default-insurance costs (CDS) which were steadily rising. (Keep in mind, that this incredible report was published before Lehman Brothers defaulted and the financial system went into meltdown.) Journalists Carrick Mollenkamp and Mark Whitehouse had figured out that the banks “had been low-balling their borrowing rates to avoid looking desperate for cash.” By suppressing Libor rates the value of the banks’ entire portfolio of financial assets increased. Here’s an excerpt from the article:

“The Journal analysis indicates that Citigroup Inc., WestLB, HBOS, PLC, J.P. Morgan Chase JPM and UBS are among the banks that have been reporting significantly lower borrowing costs for the London interbank offered rate, or Libor, than what another market measure suggests they should be. Those five banks are members of a 16-bank panel that reports rates used to calculate Libor in dollars…

The price of default insurance isn’t a perfect indicator of a bank’s credit-worthiness…but over the longer time periods.. the data provide a good picture of investors’ assessment of the financial health of banks….

The Journal analysis shows that during the first four months of this year, (2008) the three-month borrowing rates reported by the 16 banks on the Libor panel remained, on average, within a range of only 0.06 percentage point — tiny in relation to the average dollar Libor of 3.18%.

Those reported rates “are far too similar to be believed,” says Darrell Duffie, a Stanford University finance professor. Mr. Duffie was one of three independent academics who reviewed the Journal’s methodology and findings at the paper’s request. All three said the approach was a reasonable way to analyze Libor….

David Juran, a statistics professor at Columbia University who also reviewed the methodology, says that for almost all of the 16 panel banks, the calculations show “very convincingly” that reported Libor rates are lower than what the market thinks they should be, well surpassing the threshold statisticians use to assess the significance of a result….

Citigroup interest-rate strategist Scott Peng raised similar questions in an April 10 report, writing that “Libor at times no longer represents the level at which banks extend loans to others.”

Okay, so let’s break this down into plain English.

WSJ journalists Mollenkamp and Whitehouse figured out that they could (fairly accurately) measure distortions in Libor by watching the spreads on credit default swaps. (CDS) So they ran their calculations (and methodology) by reputable statisticians and finance professors to check their work. These experts, in turn, confirmed that they were on the right track and that Libor was being manipulated. The conclusion of the article is unavoidable; that the banks were gaming the system and ripping off millions of homeowners, investors etc for tens of billions of dollars.

Now that the investigation is gaining pace and public pressure is mounting, the evidence is beginning to role in. This is from Reuters:

“On Dec. 4, according to the FSA filing, a Barclays employee who submitted the bank’s Libor costs emailed a manager: “Feeling increasingly uncomfortable about the way in which (US dollar) libors are being set by the contributor banks, Barclays included.  My worry is that we (both Barclays and the contributor bank panel) are being seen to be contributing patently false rates. We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators…”

And this is from the same article:

“In late November, 2007, a Barclays employee responsible for submitting Libor borrowing costs said in an email that Libor was “not reflecting the true cost of money … Not really sure why contributors are keeping them so low but it is not a good idea at the moment to be seen to be too far away from the pack,” according to the FSA regulatory filing.”

How do you like that? Caught red-handed.

So why has it taken 4 years for the first fines to be imposed when anyone with two neurons and a frontal lobe could see that the rates were being tweaked back in 2008? Where are the regulators? Where are the criminal prosecutions? Why isn’t anyone in jail?

The stench of corruption is overpowering.

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, forthcoming from AK Press. He can be reached at

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at