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Sunday, August 5, 2012

The Libor Scandal

The Libor and Euribor (Euro Interbank Offered Rate) are used worldwide as the benchmark rates for financial transactions worth hundreds of trillions of euros. When a savings bank issues a loan to a business at a variable interest rate, the loan agreement is based on the Euribor. "In many cases, the Euribor is even the key guideline for the structuring of call money," says Falko Fecht, a professor at the Frankfurt School of Finance, referring to overnight and other such short-term loans. In Spain, in particular, tens of thousands of construction loans are based on the Euribor, while millions of mortgage loans in the United States are pegged to the Libor rate.
What happened?
They [the banking cartel] wanted to influence the giant market for interest rate and foreign currency derivatives in their favor. The volume of outstanding transactions in this area amounted to €567 trillion at the end of 2011 alone. Changes of as little as 0.01 percentage points can translate into hundreds of millions in profit or loss for some banks. This makes the lax approach to the calculation of rates taken for years by banks and regulators alike seem all the more astonishing.
According to the article, in the middle of the 2000's, traders began to conspire to fix the Libor:
Moryoussef traded in interest rate derivatives during his time at Barclays. He and his fellow traders knew exactly how much money they stood to lose or gain if the Libor or Euribor changed by only a fraction of a percentage point in one direction or the other.

And they apparently did everything they could to eliminate happenstance. Moryoussef communicated by phone or email with colleagues inside and outside the bank almost daily to steer interest rates in the right direction. To do so, they sent inquiries to the people who were responsible for inputting the Libor rates: the money market traders.

In the glitzy world of investment banking, money market traders were at the bottom of the pecking order before the financial crisis. They were not involved in major deals, and they could only dream of the kinds of bonuses stock and bond traders received. "They were always at the bottom of the food chain," says a former investment banker.

It was a conspiratorial group of underdogs who worked for various banks and met at least once a month for a beer or a mojito in New York, London or Frankfurt. By the middle of the last decade, when there seemed to be a surplus of money at the banks, they all had the same problem: They were derided or, worse yet, ignored by their colleagues in the trading rooms of major banks.

But what if it were possible to know where interest rates were headed at the end of the day, or even in the next hour? What if a few traders could manipulate the ups and downs of interest rates?

By 2005 at the latest, the traders would seem to have begun realizing just how much power they had were they able to collaborate within their small group. There was no need for formal contracts between large institutions, merely agreements among friends. A pointer here, a few traders meeting for lunch there, and soon the group had formed a global cartel that, according to investigators, reached from Japan to Europe to Canada.

* * *

While the traders were initially out to increase their bonuses, the manipulation took on a different dimension during the crisis. When the first banks began to wobble in 2007, it became more difficult for many financial companies to borrow money -- a problem that would normally be reflected in higher Libor rates.

Now even top managers at Barclays, alarmed by media reports, were instructing the Libor men to input lower rates. In October 2008, the manipulation became a question of survival for Barclays. On Oct. 29, a concerned Paul Tucker, now the deputy governor of the Bank of England, contacted Barclays CEO Diamond. Tucker wanted to know why the bank was consistently inputting such high interest rates into the daily Libor report.

Diamond told a parliamentary committee that Tucker had seemed to imply that lower interest rates be reported for the Libor, which Tucker staunchly denies. Diamond, for his part, prepared a transcript of the telephone conversation he had had with Tucker on that day, in which he had mentioned political pressure. After that, his chief operating officer spoke with the money market traders. The underdogs were suddenly being heard on the executive board, and had become the bank's potential saviors.

Barclays wasn't the only bank that was having trouble gaining access to money in the fall of 2008. UBS, Citigroup and the Royal Bank of Scotland, now prime suspects in addition to Barclays, had to be bailed out by their respective governments. Germany's WestLB, which was involved in the Libor calculation at the time, was also seen as a problem case, although this wasn't reflected in the Libor rates it was reporting.
Read the whole thing.

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