Oh dear, the banks are in trouble again.
Barclays was accused of manipulating a key interest rate benchmark called the Libor–an interest rate used to determine how much you pay for mortgages, car loans, student loans and more, affecting trillions of dollars of financial transactions. After a multi-year investigation, Barclays settled for $450 million at the end of June, and three Barclays’ big wigs resigned, including CEO Robert Diamond.
As with any juicy bank scandal, the stain has spread outward to other banks like JPMorgan and Citigroup … and even out to high-ranking government officials like Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner, and the Federal Reserve Bank of New York. (Yep, it looks like even the regulators knew about it.)
What makes this scandal especially fun to read about, however is that:
a. It comes with a set of juvenile emails where bank bros slap each other on the back for their under-the-table dealings, and ….
b. This scandal might have actually saved you money.
Why Should I Care About the Libor?
Unlike fish and chips, and Kate Middleton’s wardrobe, this is one British product that has a big effect on your wallet. Let us explain:
When you open a credit card, take out a private student loan, get a lease on a car or take on an adjustable rate mortgage, banks have to decide what interest rate to give you. This is based on a variety of factors, like your credit score. But it’s also based on how the economy and banks are doing. That is measured by the prime rate in the U.S., or the British equivalent, the Libor (London Interbank Offered Rate).
So your interest rate might read something like “3% plus Libor.” Even though you live in the United States, given that the Libor rate affects trillions of dollars in financial products, it’s very probable that the interest rate you pay on your private student loan, car lease or mortgage is based on the Libor. That means when the Libor went up, your interest payments went up. And when it went down, your interest payment shrank. In fact, according to The New York Times, Libor is one of the most highly cited benchmarks in the financial world.
So How Could It Be Manipulated?
Here’s the thing about the Libor: While you would rightly assume that it involves a complicated system running thousands of objective economic data through a computer, that’s far from the truth.
What actually happens is that each London business day, 18 large banks, like Bank of America, JPMorgan and Barclays, send in an estimate to the British Bankers’ Association (BBA) of what they would pay in interest rates to other banks to take out a loan. The highest and lowest submissions are thrown out, the rest are averaged and the result is the Libor. It’s very unscientific–really just a guess based on guesses tossed out by banks–and thus you can see why it would be easy to fudge.
Even so, this guesstimate has taken on a foundational role in financial transactions all over the world.
Why Manipulate the Libor?
There are a couple ways in which the Libor has been manipulated:
As the world economy began to panic in 2007, banks started low-balling their estimates of the interest rate to give an illusion of confidence and security. It was basically saying, “Hey, we all trust each other so we don’t expect to pay high interest rates.” Which wasn’t really true.
But there was a more insidious reason to manipulate the Libor: Many banks now have several different units with different functions. The unit that sends in the Libor estimate acts as a straight-up bank: making loans, providing savings accounts, etc. Meanwhile, other units deal in currency futures, interest rate swaps and derivatives. You don’t need to understand all these products (hardly anyone does, really). All you need to know is that whether banks made a profit on these products largely depends on the Libor. So the first unit sends in a number that could make another unit in the same bank some serious bones. See the problem here?
And Barclays has admitted to taking advantage of the system.
What a Surprise?
Actually, it wasn’t a huge surprise. Beside the fact that this investigation has been going on for a couple years, many had an inkling that something was afoot.
Two years ago, a pair of economists at UCLA and University of Minnesota released a paper comparing Libor to another competing benchmark called NYFR. The discrepancies between the two rates, they said, pointed to manipulation.
And Barclays is actually claiming that regulators approved the practice, backing its assertion up by releasing information about dozens of conversations with the Bank of England, the Federal Reserve Bank of New York and other government agencies. Now officials in both England and the U.S. are trying to figure out if it’s true that regulators let this go on.
Authorities here and abroad are also now considering action against other big banks that send in Libor estimates, including JPMorgan and Citigroup.
Yo, Want to Manipulate This For Me?
It’s not like people were being subtle about their manipulations. According to Barclays settlement with officials, “at least one derivatives trader at Barclays would shout across” the office when he was ready to ask for some help.
But the best part is the emails. Check out these golden bro tidbits:
Around Thanksgiving of 2006, a former Barclays trader who had moved on to a different bank got help from his former colleagues when they sent in a purposely incorrect estimate, and sent this reply: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.”
In another email from a Barclays’ trader to an external trader, he wrote, “Duuuude … whats up with ur guys 34.5 3m fix … tell him to get it up!!”
And you wonder why women don’t love the Wall Street culture.
Should You Be Mad?
Yes and no. On the one hand, many have editorialized that this is just more evidence of a corrupt and self-serving banking system. “The incentives of the banks is still to cheat and do things that are either illegal or immoral,” said NYU Professor Nouriel Roubini in an interview on Bloomberg TV.
But on the other hand, you may have actually benefited from the manipulation. Banks most likely manipulated rates down more than they pushed them up, which means you might have paid a lower interest rate on your mortgage or loan.
But then again, if any of your investments are in these consumer loans, you probably made less money than you would have otherwise. The City of Baltimore and a Connecticut police and firefighters’ benefit fund have filed a class-action lawsuit alleging they lost out on higher interest payments from their investments. As more municipalities, investors and financial firms pile on with litigation, the lawsuits could end up costing the guilty banks billions of dollars.
So, obviously, the manipulation has stopped, right? Bank of England official Paul Tucker isn’t sure. “I can’t be confident about anything after learning about this cesspit.”