Large banks which set one of the institutional investing world’s most important interest rate-setting benchmarks–LIBOR–are being accused of price fixing by some of the largest regulators in the world.
In a series of lawsuits filed in 2011, plaintiffs charge that dating back to the start of the current financial crisis in 2008, 19 international banks comprising the panel which determines the daily LIBOR (London Interbank Offering Rate) have manipulated market rates by hiding the actual borrowing costs of the banks on the panel.
While the majority of retail investors have never heard of LIBOR, it is a critical interest rate benchmark. The Bank for International Settlements estimates that $360 trillion in financial products worldwide use LIBOR to set interest rates worldwide.
The practice of setting LIBOR started in 1986 when nervous Russian and Arab oil company officials began to worry that their U.S.-denominated oil revenues would be confiscated by U.S. authorities. The popularity of LIBOR was also fueled by London’s growing power as an international financial center and the rise of the Eurodollar market in the 1970s.
In the lawsuits, large brokerage firms, such as Charles Schwab, and international regulators have sued 11 major banks charging them with market manipulation. As a result, borrowers which use LIBOR to set interest rates suffered reduced returns on their lending activities. The Schwab lawsuit alleges that LIBOR-member banks “reaped hundreds of millions, if not billions, of dollars in ill-gotten gains.”
How Bad Is It?
One banking executive quoted by Bloomberg, Tim Price, director of investment at PFP Group LLP, an asset-management firm in London, said “The whole system is rigged. The banks are able to say, ‘Let’s just collude and set rates, and we have the sanction of the authorities to do it.’”
International regulators, such as the Bank for International Settlements, the Commodity Futures Trading Commission, the U.K. Financial Services Authority, the U.S. Department of Justice, the U.S. Federal Trade Commission and the U.S. Securities and Exchange Commission, have questioned LIBOR rates since about 2008. A Bloomberg analysis of LIBOR rates found that “the spread between low and high rates submitted by bank panelists widens most at times of greatest financial distress.”
In practice, the suits charge that the banks comprising the LIBOR panel mis-stated their actual borrowing costs to drive up rates. These rates affect the borrowing costs charged in large financial transactions, such as swaps, margin loans, mortgages and other credit lending products, retail and institutional.
One example stems from the collapse of Lehman Brothers on Sept. 15, 2008, when the rate spread submitted by LIBOR bank-member panelists on three-month loans rose from 7 basis points to 115 basis points by the end of the month.
The Schwab suit contends that LIBOR-panel banks violated U.S. commodities and antitrust laws and state common law by manipulating LIBOR and prices of LIBOR-based derivatives in various markets worldwide.
Some of these derivatives, such as mortgage-backed securities (including Collateralized Mortgage Obligations) were cited as being major contributors among the financial products causing the housing crash in 2008.