The Lebowski Blog: The LIBOR Scandal is the Largest Financial Scam in History - $350 Trillion

"Where's the f'ing money, Lebowski?"

It's a sad testament to finance when the largest scam in the world's history goes by un-noticed, mainly because it is boring.

You may have come across the term LIBOR in the news pages recently in relation to  Barclays capital, a banking and financial services company that recently was fined for manipulating the London Inter-Bank Overnight Rate  or LIBOR (seriously, could that sound more boring?).

The London Inter-Bank Overnight Rate (or LIBOR) is the average at which 18 banks based in London loan money to each other.  Banks predict what rate they think they will have to lend at the next day and send this information to Canadian information giant, Thomson-Reuters.  Thomson-Reuters then calculates rates and publishes them the next day.   The whole process is controlled by the British Bankers Association, but mostly relies on banks policing themselves in the rates they submit. Again, not exactly thrilling stuff.  

But it is.  Comments on the scandal include Andrew Lo,  professor of finance at the MIT saying, "This dwarfs by orders of magnitude any financial scams in the history of markets."  A writer in Rolling Stone has a friend on Wall Street who "is just stunned to the point of near-speechlessness by the LIBOR thing. “It’s like finding out that the whole world is on quicksand,” he says."  The Guardian is calling this "A worldwide conspiracy against the functioning of the free market."

But it's complicated.

Why do banks loan to each other over night?  It's mainly to do with capital requirements.  As we've mentioned in previous blog discussions "Banks often require short-term loans to balance their books on a nightly basis.  Before the recession they would usually get this from another bank (inter-bank lending) for a short-term period."

Of course, during the height of the financial crisis, this stopped happening.  Banks stopped lending to each other overnight because they were afraid of a Lehman Brothers scenario where they would loan money to a bank and it would then collapse the next day.

This is why all over the world, including in Canada, central banks stepped up to loan money to banks.

As the crisis subsided a bit in 2009 and loans from central banks wound down, banks started lending each other money again, but the rates went up.  For a bank that was in trouble, the rates went up higher.

For a bank in trouble, a high overnight rate rate is bad as it indicates the bank is having trouble raising money.  Because Thomson Reuters also publishes the individual overnight-rate submissions for the banks that make up LIBOR, the entire world would be able to determine if bank is in trouble, which was particularly dangerous during the financial crisis.

Because of this, allegations are rife that a number of banks in London were manipulating their rates lower to be seen as having a better financial situation.

It worked pretty simply.  Numerous e-mail correspondences from Barclays shows that traders were e-mailing the people who submit the rates and asking them to change the submissions.  Manipulations to the rates they submitted were being done sometimes on a daily basis and were being done not just at Barclays.

While all of this is pretty clearly illegal, it also might sound pretty minor.  After all, if a bank is just fudging its submissions to seem like it is in a better financial submission, how bad could the consequences possibly be?

Pretty bad, it turns out when people find out that the LIBOR rate affects between $350-$700 Trillion in financial contracts.  That's right.  Trillion.

The LIBOR rate has been seen as a constant and stable indicator on which to rate the banking sector.  Because it is the cost that it takes a bank to raise money, it has been seen as a pretty solid indicator of the real cost of money for a large financial institution.  Because of this many, many, many large institutions base their contracts on LIBOR including trillions of dollars in derivative contracts that are owned by pension funds and investment banks.
 
The manipulation of the rates cost a lot of people a lot of money.  Banks and investment firms that were supposed to be paying interest rates at the LIBOR percentage plus 1% were all of a sudden paying lower than what they were supposed to.  Thousands of them were paying lower. Billions lower.

And the lawsuits are starting to pour in.  US investor Charles Schwab has filed suits claiming the suppression of LIBOR cost them $45 Billion.

But the scope of the fraud is even worse.  LIBOR is just the most commonly known and used rate for lending.  There are many more including EURIBOR (EU banks), TIBOR (Japanese), SIBOR (Singapore) and HIBOR (Hong Kong).

Disclosures by the US Department of Justice reveal that a network of traders have been trying to influence LIBOR and EURIBOR and they've been doing so for years.

Submissions against Barclays showed the bank was manipulating the rates since 2005, well before the financial crisis.  And they weren't just manipulating it down to make themselves look stronger financially.  Traders also pushed rates higher when investors owed Barclays money based on the LIBOR rate.

It wasn't just Barclay's or LIBOR or London Banks.  Former traders have been explaining that manipulating overnight rates was common in many banks and has been going on for 20 years.

Canada's financial sector too. According to the Guardian, Canada's Competition Bureau filed an affidavit against a number of banks demanding e-mails and other documents in relation to rate fixing.  One bank who apparently communicated with traders all over the world has turned whistleblower claiming the banks involved "communicated with each other…to form agreements" to make more money off things based off rate setting.

Unfortunately, as per usual, massive illegal activities aren't generally prosecuted or enforced when they are being undertaken by rich people.

Testimonials from traders seem to indicate that the fraud carried out was so above board and involved so many layers of management that people seemed to have forgot (or not cared) that is was illegal.

There's likely a good reason for this.  Like the massive fraud involved in the subprime scandal there's been no talk of jail time, not to mention stricter regulations. Fines will be low.  

In fact, Barclays fine was a paltry $290 million dollars which was considered large.  It paid $2 Billion in bonuses alone in 2010.  The fine is even more ridiculous when you consider the following:

The fine was paid to the Financial Services Authority (FSA).  The FSA, naturally, is not a branch of the government, but an independent semi-government agency that is funded completely by the banks themselves.  The fine against Barclays and other banks in the future, will likely mean that the fees they pay to the FSA will be lower.  In other words, any fines they pay could actually save them money next year.

The Lebowski blog tracks big piles of money.  It appears regularly on the Toronto Media Co-op.