Central Banks Knew About LIBOR Manipulation For Years—Here's Why They Didn't Do Anything:
A document dump from the
Federal Reserve Bank of New York earlier today indicates one thing: the Federal Reserve, the
Bank of England, and the British Bankers Association knew that traders were misreporting the data used to calculate one of the world's most important financial benchmarks for years.
And there are a few really good reasons they did nothing.
The London Interbank Offered Rate (LIBOR) serves as the benchmark rate for lending in dollars across the world, serving as the basis for mortgage rates, credit cards, commercial loans, financial derivatives—you name it.
Every day, 18 banks from around the world tell Thomson
Reuters the price they would pay to borrow money. Thomson Reuters compiles that data, cutting off the highest and lowest four rates submitted, and the BBA publishes a composite LIBOR number.
Documents published by the NY Fed today cite discussions in which traders admitted they were not reporting accurate borrowing rates. Take this
phone conversation between a Fed analyst (FR) and an anonymous trader at Barclays on April 11, 2008:
[Redacted]: You know, you know we, we went through a period where
FR: Hmm.
[Redacted]: We were putting in where we really thought we would be able to borrow cash in the interbank market and it was
FR: Mm hmm.
[Redacted]: Above where everyone else was publishing rates.
FR: Mm hmm.
[Redacted]: And the next thing we knew, there was um, an article in the Financial Times, charting our LIBOR contributions and comparing it with other banks and inferring that this meant that we had a problem raising cash in the interbank market.
FR: Yeah.
[Redacted]: And um, our share price went down.
FR: Yes.
[Redacted]: So it’s never supposed to be the prerogative of a, a money market dealer to affect their
company share value.
FR: Okay.
[Redacted]: And so we just fit in with the rest of the crowd, if you like.
FR: Okay.
[Redacted]: So, we know that we’re not posting um, an honest LIBOR.
FR: Okay.
[Redacted]: And yet and yet we are doing it, because, um, if we didn’t do it
FR: Mm hmm.
[Redacted]: It draws, um, unwanted attention on ourselves.
FR: Okay, I got you then.
[Redacted]: And at a time when the market is so um, gossipy, and
FR: Mm hmm.
[Redacted]: Prone to
FR: Mm hmm.
[Redacted]: Speculate about other names
FR: Mm hmm.
[Redacted]: In the market
FR: Mm hmm.
[Redacted]: It’s um
FR: Mm hmm.
[Redacted]: Not a useful thing for us as an organization
FR: Mm hmm.
[Redacted]: To do. And in fact, wha-what we’ve noticed is almost like um, a um, um perverse thing where people that we know that are paying for money actually put in the lowest LIBOR rates.
FR: Okay.
[Redacted]: So it, it’s almost to um, you know the ones that need cash the most put in the lowest, lowest rates.
This conversation points to two things. First, it confirms that the NY Fed knew about LIBOR manipulation. In other documents—
particularly in an email chain beginning on June 1 of that year—it is clear that they voiced concerns about this to the BoE and the BBA.
Second, these documents suggest LIBOR manipulations were based primarily on funding stress connected with the imminent financial crisis at that time. Unlike revelations about attempts to distort LIBOR back in 2006, by early 2008 all the banks were doing it because the credit markets were tightening.
Indeed, the
Barclays trader cited in the conversation above suggests that had Barclays not adjusted its rates, it would have been the subject of market angst.
In this environment, it is clear that then-NY Fed Governor Timothy Geithner was concerned about manipulations of a benchmark market rate. However, it should be no surprise that he could not do much about it.
By early 2008, ominous signs were becoming apparent about the imminent financial crisis. Just a few months after emails discussing LIBOR were exchanged,
Lehman Brothers fell and the entire financial system began falling apart.
This was not the kind of environment in which the Fed could actually call banks out. At this time, banks were distorting their LIBOR submissions because they had no other choice—higher borrowing costs were a very public and probably false signal of financial stress, and banks couldn't afford to be the center of market angst during such a tumultuous period.
Lower than realistic rates were a positive sideshow for a system that was falling apart. In the months to follow conversations like the one cited above, the last things central banks were probably concerned about was that banks were underreporting lending rates, and trying to convince increasingly wary investors that they were a good credit risk. Banks needed funding to stay afloat, and internal or even coordinated efforts to make that slightly easier were just not an important concern at that time.
Finally, it's not clear that the Fed could have successfully addressed problems of LIBOR manipulation, even with the suggestions they fielded to the BoE. In particular, the Fed pointed out that averaging a random sample of bank submissions could have diminished the impact of one or two faulty rates. But at a moment where investors were considering each bank's submission individually as an indicator of funding stress, such a change would not have dissuaded even the most stable banks from manufacturing lower borrowing rates than they were actually seeing. Indeed, there's nothing to stop the same thing from happening if credit tightens once again.
Recent allegations of bad behavior dating back to 2006 have proved that
systematically dishonest practices with regards to manipulating the LIBOR rate started well before the financial crisis. And as TF Markets' Peter Tchir points out,
such manipulations were often not very effective.
Admittedly,
an academic report from 1998 raises questions about whether or not the Fed should have addressed concerns about LIBOR manipulation some fifteen years ago. However, at the time of these documents, the Fed had a lot more important things to worry about—and an under-reported LIBOR was certainly not hurting.
Were traders making money from distorting LIBOR during the financial crisis? Probably. But in the overwhelming volatility witnessed during that period, it's going to be difficult to actually find all but the most egregious moments in which banks altered their submissions from the day before more or less than they should have.
And should the Fed have actually been spending the time and energy to call these banks out as the economy deteriorated in 2008? For the sake of the greater health of the financial sector, probably not.
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