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The Libor Interest Rate Manipulation Scandal Has Been Brewing for Years

Interest-Rates / Market Manipulation Jul 05, 2012 - 07:08 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleThe Barclays Libor manipulation scandal is the latest development out of a huge investigation in the global banking industry - one that would have started years earlier, if Money Morning's Shah Gilani was in charge of it.

You see, Libor rates are incredibly important. They're the benchmark, or "reference," rates for hundreds of trillions of dollars in loans.


They are so important that even a 0.10% error or "manipulation" in calculations could impact billions of dollars.

That's why Gilani has been warning Money Morning readers of the risks of Libor manipulation since 2008.

"Gilani was among the earliest proponents of the theory that the contributing banks may have rigged the calculation of LIBOR," wrote Securities industry lawyer and Wall Street regulation critic Bill Singer in 2011. "Gilani warned that such activities were likely antitrust violations and were exposing major international banks to legal liability."

How Libor Manipulation Began

As Gilani explained in October 2008, how banks manipulate Libor isn't an incredibly complex event. That's because loan rate reporting is based on the honor system.

Or dishonor, in some cases.

The dollar Libor rate is calculated based on the submission of quotes from 16 major world banks. The banks submit data as to what they paid, or could pay, to borrow from other banks at each maturity level. The four highest and lowest numbers are thrown out and the average of the middle eight is used to calculate the lending rate.

How high or low the lending rate is speaks to the health of the banking system.

"If banks are seeking to charge one another higher rates, that's telling us one of two things," said Gilani. "Either banks don't have excess cash to lend, or they are unwilling to lend freely to other banks, which they fear are facing potential troubles because of bad loans, defaulted mortgages, and other pending hits to their capital and threats to their solvency."

Therefore, no bank wants to admit it is charging or being charged a higher-than-average rate to borrow. That sends a bad signal about the bank's financial strength and stability.

So what can troubled banks do? Lie about their rates, of course, to make or save money for themselves by keeping Libor rates artificially low.

Gilani wasn't the only expert at Money Morning to uncover the "rate rigging" banks were involved in well before these institutions got in trouble.

Back in April 2008, Money Morning's Martin Hutchinson noted that banks were making false Libor quotes in order to avoid being thought of as unstable credit risks, because then other banks would demand a premium.

But as Hutchinson pointed out, some banks were riskier and carried higher credit risks, and therefore should have been paying a premium for their deposits.

U.S. Regulators: Too Little, Too Late?

Three years after Gilani and Hutchinson's warnings, the U.S. Department of Justice's Antitrust Division announced it was investigating whether as many as 16 major banks colluded from 2006 through 2008 as part of a scheme to manipulate Libor.

But by then, the Antitrust Division's meager resources were so heavily saddled with investigations and cases that it was unable to act swiftly.

Too bad no one looked into the concerns when Money Morning first did, before the credit crisis tore through the country, leaving behind a distressed financial landscape.

Had regulators heeded Gilani and Hutchinson's warnings, the 2008 financial crisis may have packed a lighter punch.

"By artificially keeping rates low, did the manipulation game create more cheap lending across all mortgages and loans during the run-up to disaster?," Gilani wrote last week. "Did these banks facilitate the lending by which they all prospered across the board (until the music stopped and there weren't enough chairs; actually there weren't any chairs) by manipulating rates? You bet they did."

This manipulation is part of daily business for some bankers, and Gilani warns that only giving the guilty a slap on the wrist will keep the problem around forever.

"It's criminal that regulators and governments haven't put the guilty in jail, but let them pay fines and go back to their dirty business as usual," said Gilani.

And Barclays isn't the only guilty party.

"They're not alone," said Money Morning Capital Waves Strategist Shah Gilani. "There will be a bunch of other big banks paying for this gross game of manipulation. And all of them are household names."

To keep up with what Gilani sees next in this scandal, and get his inside look at Wall Street corruption, click here to sign up for his Wall Street Insights and Indictments newsletter. It's free.

Source :http://moneymorning.com/2012/07/03/the-libor-manipulation-scandal-has-been-brewing-for-years/

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Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

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