As Adam Prussin reports in the current issue of The Pomerantz Monitor, a few weeks ago news erupted of what may be the worst financial scandal in years: the systematic manipulation of interest rates by the largest banks in Europe and the U.S. On June 27 the Department of Justice and regulators in the U.S. and England announced that they had reached a settlement with Barclay’s, the giant British bank, in a case involving the fraudulent fixing of the so-called LIBOR interest rate. LIBOR (short for “London interbank offered rate”) is the benchmark for trillions of dollars of loans worldwide – mortgage loans, small-business loans, personal loans, and interest rate derivatives contracts called swaps.
The regulators allege that Barclay’s made false daily submissions to the British Bankers’ Association – which calculates LIBOR – probably from 2005 to 2009. The submissions are not based on an actual market rate of interest for interbank loans. Rather, submitters estimate what they think they would have to pay.
Obviously, since all the big banks submit data, Barclay’s normally could not manipulate LIBOR by itself; they would all have had to cooperate. And now, in its settlement agreement, Barclay’s has admitted that this is exactly what happened, with the result that LIBOR deliberately underestimated the interest rates that the banks were paying for loans.
This is no ordinary scandal, because this time there will likely be big-time consequences. Barclay’s has paid $453 million to settle the cases; and its Chairman, CEO and CFO have all been forced to resign. The four top executives of the firm reportedly voluntarily agreed to give up their bonuses this year. But that is only the tip of the iceberg.
The manipulation of LIBOR has resulted in distorted interest rates being charged for trillions of dollars of loans, and it has also affected thousands of transactions in derivative securities, including interest rate swaps whose profitability depended directly on movements in the LIBOR rate. Anyone who came out on the short end of those deals will have a great case.
For example, Charles Schwab, the brokerage firm and investment manager, has sued 11 major banks, claiming they conspired to manipulate LIBOR. Schwab contends that these banks altered the interest rates for LIBOR-based securities and deprived investors of the returns they would have earned had the numbers been accurate. The firm also alleges that by falsely depressing their borrowing costs, the banks “provided a false or misleading impression of their financial strength to investors” during the financial crisis of 2008.
Municipalities, pension funds and hedge funds have also filed actions alleging that they received smaller payments under their financial contracts with banks (typically, interest rate swaps) than they would have received had LIBOR been set honestly. According to The New York Times, one of the most significant actions was filed by traders and hedge funds that entered into futures contracts, traded over the Chicago Mercantile Exchange, that make payments calculated in reference to LIBOR. Pomerantz is currently working with banks that were not involved in reporting LIBOR, but received lower interest payments on floating-rate loans due to the manipulation of LIBOR rates. We anticipate filing a case on behalf of injured lenders shortly.
There is serious potential here for criminal liability. The Justice Department case against Barclay’s, for example, was a criminal case; and Barclay’s entered into a so-called “non-prosecution” agreement with the Department as part of the settlement. This agreement does not, however, immunize individual officers and employees of Barclay’s from criminal prosecution, which now seems to be inevitable. How far up the ladder the cases will go remains to be seen. The U.S. Department of Justice is also continuing its probe into whether other banks and individuals rigged LIBOR and the Euro Interbank Offered Rate as well, and has made it clear that it is contemplating bringing criminal actions, most likely later this year. Across the pond, on July 6, the U.K. Serious Fraud Office announced it had officially opened a criminal investigation into the country's banking industry in the wake of Barclay's settlement.
Barclay’s was forced to capitulate because, from all reports, the evidence of its culpability was overwhelming. Reportedly, Barclays’ traders’ emails give a chilling picture of how easily they got their colleagues to go along with this scheme. Robert Diamond, Jr., the former Barclays CEO who was forced to resign, testified to Congress after the settlement was announced that these emails made him “physically ill.” Among them is a series of exchanges between the bank’s traders and the bank’s LIBOR submitters, with traders expressing gratitude for fudged numbers in terms like, “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.” Another one reportedly said that "Coffees will be coming your way either way, just to say thank you for your help." Yet another said, "When I retire and write a book about this business your name will be written in golden letters." The submitter responded: "I would prefer this not be in any book!"
Why would they do it? Fear played a big part. During the period just before the financial crisis, around 2007, as the financial condition of the banks deteriorated seriously, Barclays and other banks lowballed their rate estimates in order to disguise how much trouble they were in. Had they been truthful, that would have been a red flag of their weak financial condition. Barclay’s seems to have been in the worst shape, and was unwilling to disclose that its borrowing costs were higher than its rivals’. It therefore asked its employees to lower the rates submitted to the Libor committee to keep the bank’s reported borrowing rates in line with those of other big banks.
Simple greed also played a major role in this scandal. Starting around 2005, the banks were rigging LIBOR in whatever way necessary to assure their bets on derivatives would be profitable, including bets on interest rate swaps. The fact that banks could buy and sell such swaps, while at the same time setting the rates that the swaps were betting on, is a colossal, and obvious, conflict of interest. At other times, the banks had entered into agreements with institutional investors requiring the payment of interest at a rate based on LIBOR. By lowering that rate, the banks were saving themselves a boatload of money - at the expense of their counterparties.
While Barclay’s was the first bank to settle, it won’t be the last. JPMorgan Chase & Co., Citigroup Inc., Bank of America, HSBC and Deutsche Bank AG, are all reportedly in the crosshairs. More settlements, and more horrific disclosures, are probably in the forecast for the foreseeable future.