Who will save us from the Masters of the Universe and the Wall Street wizards? In 2008 they brought the globe to the brink of financial collapse and last week they destroyed the integrity of the London Interbank Offered Rate (LIBOR), the benchmark used to set interest rates world-wide. Here’s how Barclays bank did it and why.*
Before we start there are two things you need to know about LIBOR.
One—LIBOR is set by the British Banking Association (BBA). Each day BBA asks 16 banks to submit their interbank interest rates—the interest rate another bank would charge the submitting bank if it wants to borrow money. This interbank rate is set for a number of currencies and for 15 time periods ranging from overnight loans to one year loans. BBA ignores the 4 highest and 4 lowest submissions and averages the remaining 8 to set the LIBOR for all of those currencies and time periods.
Two—the rate submitters, the bank’s treasury department, are not supposed to talk to the bank’s traders in the rate setting process because the traders sell financial instruments based on LIBOR. If the traders can influence the LIBOR they would have to draw upon every fiber of their moral being to resist the urge to fiddle the LIBOR in their favour.
Fiddling the LIBOR for Personal Greed
On the topic of moral fiber, Barclays traders recognized that if they could convince Barclays’ rate submitters to submit LIBOR numbers that suited their deals they would maximize Barclays’ profits and minimize Barclays’ losses—and boost their bonuses to boot! Of course this meant that the person on the other side of the deal, the mortgage company, pension fund, insurance company, whoever, would make a smaller profit or suffer a greater loss which increased costs to the consumer, but who cares.
Emails between Barclays’ traders, rate submitters and outside traders demonstrate how blithely this was done. The LIBOR under discussion is a rate which will go into effect 3 months hence (the 3 m libor).
Trader 1: “where do u think 3 m libor will be today?”
Trader 6: “submitter thinks 38”
Trader 1: “wow…unchanged!!?!???!…if it comes in unchanged I’m a dead man ha ha”
Trader 6: “I’ll have a chat”
Later that day Trader 1 contacts Trader 6: “Dude, I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger! Thanks for the libor!”
Trader 6 (who, in addition to a lack of morals, doesn’t know how to spell): “know worries!!!”
Did the traders know they were doing something wrong? Some say that the existence of these emails is proof that the traders weren’t trying to hide their actions—they thought it was fine. Another possibility is that the traders were too dense to realize that their emails, text messages and recorded phone calls live forever in the ether and would respond to the siren call of a subpoena. (That’s one of the problems with being a Master of the Universe, these mundane details can slip by you.)
Fiddling the LIBOR for Corporate Self Preservation
In addition to the manipulation of LIBOR by individual traders, Barclays deliberately understated its LIBOR submissions to BBA. It wanted to avoid the impression that other banks were concerned about its financial health and were charging it higher interest rates for interbank loans.
Interestingly, Bob Diamond, Barclay’s ex-CEO, says the Bank of England was aware that Barclays and other banks were understating their LIBOR submissions and implicitly approved this practice. Mr Diamond says Mr Tucker, Deputy Governor of the Bank of England, told him that it did not always need to be the case that [Barclays] appeared as high as [it had] recently”. Mr Diamond passed this message on to his Chief Operating Officer who instructed his staff to continue to underreport the interbank rate.
Mr Tucker denies this allegation. But consider this: Barclays contacted the UK securities regulator, the Financial Services Authority (FSA), 13 times in the course of a year**to express concern that all banks were understating LIBOR to protect their reputations in the fallout from the 2008 financial crisis. Barclays told the regulators that it was “not clean clean, but clean in principle” and “we’re dirty-clean, rather than clean-clean”. Good lord, do the regulators need to be hit over the head with a mallet?
Barclays was fined $451.4 million for its misconduct. Barclays’ CEO and 3 other top executives graciously offered to forgo their bonuses for the year. That promise vapourized when the CEO and the COO abruptly “resigned”. There are no criminal charges pending against any of Barclays executives. The bank was granted “leniency” for cooperating with the investigation.
Prime Minister David Cameron called for a parliamentary inquiry into the UK banking industry. The inquiry will likely recommend even more legislation.
That would be unfortunate. The last thing we need is another arcane and ultimately ineffective law to address the problem of gross irresponsibility bordering on criminality in the finance industry. A quick look at the Dodd-Frank Act demonstrates that in spades. What we need is the creative interpretation of existing criminal, quasi-criminal and securities legislation already in place and the political will to enforce it.
If the Masters of the Universe are facing jail time, the loss of their personal fortunes and the prospect of being barred from ever working in banking again (goodbye fat bonuses and cushy directorships), they might think twice before rolling the cosmic dice for their own personal gain.
*Research for this article is taken from articles in the New York Times Online (Sept 7, 2010, Jun3 27, 2012, July 2, 3, 4, 2012 and Reuters.com June 28, 2012.
**Barclays contacted the US Federal Reserve 12 times in the same one year period.