Part 5: Big Banks Misbehaving: Rate-Rigging

October 1, 2012 | St. Louis Mo.

Emmons gives a history of the Libor (London Interbank Offered Rate) rate and its use and importance within the world's financial markets. He then delves into the allegations that Barclays UK and other banks submitted false Libor estimates to 1) increase its profits from other its activities in other trading markets like derivatives and 2) signal the banks were stronger than they really were during the financial crisis. Many other banks are now under investigation as well.

Presentation (.pdf)


William Emmons: Third, rate-rigging. So I'll talk a little bit about how Libor, and I'll explain what that means, how this rate, set of rates is supposed to work. What Barclays and some other banks actually did, how they were found out, and what's happening now.

So first, what is Libor? It's the London Interbank Offered Rate. It's actually a whole schedule of rates. It's a daily publication of short-term rates that banks would believe they would have to pay to borrow from another bank. So a high quality bank borrowing from another bank at a varying range of maturities from one day up to 12 months. And it's also the whole set of Libor rates includes 10 different currencies. So you can see there's a very large number of actual rates published every day when we talk about Libor.

The British Bankers' Association is a private group. Up until today they collect a full set of rates from a panel of banks in each currency. For the U.S. dollar it's 18 banks. They take the bottom 25 percent, throw them out in terms of the rate submitted. The top 25 percent, throw them out. And then the average of what's left is what's published for each of those maturities and each of those currencies.

So what Barclays and some other banks apparently did was sometimes submit false Libor estimates. And they were knowingly false. For two reasons. One, to increase the bank's profit in other markets. In particular, for example, derivatives markets that might have some reference to a Libor rate. The second reason was during the financial crisis to signal that the bank was stronger than it really was. If a bank's financial health deteriorates typically it would be required to pay a higher rate. So by reporting a lower rate than would actually be the case if they were to try to borrow, that overstates their financial strength.

So how do we know this happened? Again, as in the two previous cases, there's not really a dispute about whether this happened or not. And, in fact, we have the smoking gun, in this case was lots and lots of e-mail evidence that points in this direction. Here's a direct quote from an e-mail from a Barclays trader to the Libor submitter, "We have another big fixing tomorrow," (that is a rate fixing or probably other contracts), "and with the market move I was hoping we could set certain Libors as high as possible."

Another Barclays trader said, "When I retire and write a book about this business, your name will be written in golden letters," to the Libor submitter. Who responded, "I would prefer this not to be in any book."


Another Barclay—these could be the same trader. We don't know. "Dude, I owe you big time. I'm opening a bottle of Bollinger."

And then one executive to another at Barclay said, "We're clean, but we're dirty clean rather than clean clean."

So back up a little bit. Libor long was known to be flawed, to be imperfect. In fact, you can find evidence at least as far back as the 1970s, that it was fairly well understood in financial markets that there were some problems. The specific example is that in the Chicago derivatives markets when they were starting new interest rate contracts they needed a specific interest rate to use in that contract. The creators of that Euro-Dollar Futures contracts decided not to use Libor because they considered it unreliable and subject to manipulation.

Well, some years later those contracts in fact were rewritten to reference Libor. Why? Not because they had changed their minds about its unreliability, but because it had become very widely accepted in other contexts and in other markets. And so it was more convenient for the futures and options contracts to be in alignment with some of the other markets that were using that rate.

At the beginning of the financial crisis the Bank for International Settlements and others publically criticized the Libor rate setting processing. So it was not a mystery that there were problems, there were at least some vulnerabilities in this rate setting process.

Well, in June of 2012 after apparently a several year-long investigation, the Commodity Futures Trading Commission, the Department of Justice, and in the U.K. the Financial Services Authority signed a settlement, Barclays admitted manipulating the rates, knowingly submitting false rates over a multi-year period. And they agreed to pay $450 million to both U.S. and British authorities. And they agreed to force out the CEO, the chairman of the board and the CFO, the Chief Financial Officer. So it was a very, very significant lapse of corporate governance admitted by Barclays.

Today, not only Barclays, but many other banks are under suspension, there's a fairly long list. They are being investigated in the U.S., the U.K. and other jurisdictions, Japan, for example. Also, there's a lot of heat being put on the Federal Reserve and other regulators, because in congressional testimony currently Treasury Secretary Tim Geithner, who was the president of the New York Fed at the time, said that they knew about the questions about whether these rates were accurate. The New York Fed communicated with the Bank of England expressing concerns. But the criticism today is that the New York Fed didn't take enough aggressive action, or the Federal Reserve more broadly, in cracking down on these problems.

The most recent development, last Friday the Financial Services Authority in the U.K. has stripped the British Bankers' Association of its Libor oversight role and said that it will be restructured. Some new administrator of this rate will be appointed in the next 12 months.

In congressional, or the equivalent, the parliamentary investigations in the U.K., the deputy governor of the Bank of England, Paul Tucker, ominously stated, "We would be fooling ourselves to assume that trading manipulation was limited to Libor trades." So kind of a depressing litany when you think about it. As Julie said, how can these things go on in markets apparently as sophisticated, as competitive as they are today?

Well, we're going to delve into that, but first a little feedback from you. Of these issues, robo-signing, botched hedging and Libor rate-rigging, which do you think is the most concerning?

Okay. Libor rate-rigging is the most, is of the greatest concern to most people. Okay. We might come back to that in our discussion and maybe get some idea why it is that people are most concerned about the rate-rigging. Okay. And then for equal concern also, which is pretty high.