(NEW YORK) MintPress – It has not been a good month so far for the banking industry. First, HSBC, the big British bank, agreed to a $1.9 billion settlement over money laundering. Then came the arrest of three London traders on suspicion of interest rate manipulation — with several more expected to follow.
The arrests are the latest developments in the ongoing investigations into manipulation of LIBOR — the London interbank lending rate that is key to the global financial system — which is the biggest scandal since the 2008 financial scandal.
LIBOR refers to the interest rate that a bank charges another bank; it is an average interest rate calculated through daily submissions of interest rates by a group of major banks in London.
But it also plays a huge role in everyday loans. Mortgages, many student loans and car payments are pegged to LIBOR, as are myriad financial instruments, including 70 percent of the U.S. futures market.
The scandal arose when it was discovered that banks were falsely inflating or deflating their rates in order to profit from trades or give the impression that they were more creditworthy than they were.
Britain’s Serious Fraud Office (SFO) and City of London arrested the three men, ages 33, 41 and 47, early Tuesday after searching their homes. They were taken to a London police station to be interviewed “in connection with the investigation into the manipulation of Libor.”
One of the men has worked for a number of banks, including UBS and Citigroup, and two men worked for broker RP Martin.
“These rates are at the absolute core of our global financial system,” said Gary Gensler, chairman of the Commodity Futures Trading Commission (CFTC), in a recent interview with Time. If they are falsely reported, he maintained, “that goes to the integrity of markets and how much trust the public has in them.”
Anatomy of a scandal
For now, the public’s trust has been seriously tested.
On June 27, after four years of investigation by the CFTC, Barclays became the first major bank to publicly admit that it had been rigging the rates it submitted for LIBOR for years, paying $450 million in fines as a result.
Chairman Marcus Agius, Chief Executive Bob Diamond and newly promoted chief operating officer Jerry del Missier all resigned.
No other individuals involved were formally named. Barclays’ head of investment banking, Rich Ricci, said that the bank had “terminated the employment” of five people and that 13 staff had been disciplined in total.
By early July, the scope of the scandal was becoming clear. On July 6 it was announced that the SFO had also opened a criminal investigation into manipulation of interest rates.
More than a dozen global banks are now under investigation by the CFTC, the SFO and other U.S. and European regulators for falsely reporting or manipulating LIBOR.
“It turns out, through this investigation, that banks have been monkeying with these rates, some people say dating back to the early ’90s, for a variety of reasons,” said Matt Taibbi, contributing editor for Rolling Stone and author of “Griftopia: A Story of Bankers, Politicians, and the Most Audacious Power Grab in American History”.
“One reason that is given is that during the crisis in 2008, regulators wanted the system to look healthier than it was, so they artificially allowed it to inflate,” he explained
“But it also appears that they were messing with the rates in order to personally make profits on their investments, which is incredible, because Libor affects about $800 trillion worth of financial products worldwide, so fixing the prices of Libor is an enormous thing.”
According to financial news agency Bloomberg, early estimates are that the rate manipulation scandal cost U.S. states, counties and local governments at least $6 billion in fraudulent interest payments on top of $4 billion that state and local governments have already had to spend to unwind their positions exposed to rate manipulation.
Tip of the iceberg
Congress began its own investigation in July. Senate Banking Committee Chairman Tim Johnson (D-S.D.) said he would question Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke about the scandal during scheduled hearings.
Rep. Randy Neugebauer (R-Texas) chairman of the House Financial Services Committee, wrote to New York Federal Reserve President William Dudley seeking records of communications between the New York Fed and Barclays between August 2007 and November 2009 related to Libor-like rates.
On Oct. 4, Republican Sens. Chuck Grassley and Mark Kirk announced that they were investigating Geithner for complicity with the manipulation scandal. They accused him of having but not acting on knowledge of the rate-fixing.
The senators said that an American-based interest rate index is a better alternative which they would take steps toward creating.
Meanwhile, the British Bankers’ Association said on Sept. 25 that it would transfer oversight of LIBOR to U.K. regulators, as proposed in Financial Services Authority Managing Director Martin Wheatley‘s independent review recommendations.
Wheatley recommended that banks submitting rates to LIBOR must base them on actual inter-bank deposit market transactions and keep records of those transactions, that individual banks’ LIBOR submissions be published after three months and that there be criminal sanctions specifically for manipulation of benchmark interest rates.
The British government agreed to accept all of the recommendations and press for legislation implementing them.
But change is not going to come overnight. “This dwarfs by orders of magnitude any financial scam in the history of markets,” said MIT Professor Finance Andrew Lo.
Professor of Law at the University of New South Wales Justin O’Brien said the need for the public interest to be considered first and foremost in the reform of global financial systems has never been greater.
“Society has a right to expect better,” he wrote in an editorial this week. “Regulators have a duty to ensure protection is offered and political actors have an obligation to ensure the lessons of history are learnt, not repeated.”