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Barclays Libor Scandal: The Precedent

Posted by Larry Doyle on July 16, 2012 3:15 PM |

Although many on Wall Street would like to see this Libor scandal go away, that is not going to happen. With banks already admitting that they were involved in the manipulation, the public rage resulting from this massive fraud is only going to grow stronger. Rest assured legal defense teams on Wall Street are working overtime on this case.

Remember, Libor is used as a benchmark for trillions of dollars worth of securities and contracts. A basis point here or there equates to literally billions of dollars — if not more — in misallocated and misappropriated funds. 

There is certainly plenty of fuel in this Libor fire to stoke the rage of global investors for a long time. Emails already released acknowledge that traders involved in this manipulation knew the activity was blatantly dishonest. Yet it persisted for years. How? Why?

This price-fixing scandal looks so familiar to the same sort of activity typically connected to organized crime. Those within the banks were driven to maximize profits. Those charged with regulating the markets were captured by the industry and served to protect the industry’s interests rather than the interests of investors.

Ultimately, the smoke around the manipulation became too dark and overwhelming and the manipulation could not be kept under wraps. Future developments with this story are surely scaring the hell out of a lot of individuals right now. The potential for criminal charges is clearly unsettling.

Are we to believe that Wall Street has never before been involved in rigging and manipulating markets?

1. We know that Wall Street banks manipulated the auction-rate securities sector to give the appearance of a healthy market when the auctions would have otherwise failed. Anywhere else?

2. Actually if we were to go all the way back to the late 1980s and into the early 1990s, another short term rate utilized to benchmark borrowing activity was also widely believed to have been compromised.

Really? What rate was that? Let me introduce you to the 11th District Cost of Funds (COFI), which

. . .  is one of many indices used by mortgage lenders to adjust the interest rate on adjustable rate mortgages. The COFI is computed from the actual interest expenses reported for a given month by the Arizona, California, and Nevada savings institution members of the Federal Home Loan Bank of San Francisco (Bank) that satisfy the Bank’s criteria for inclusion in the COFI (COFI Reporting Members).

In addition to the COFI, the Bank publishes semiannual weighted average cost of funds indices for California and the 11th District.

In speaking with former traders on Wall Street we were reminiscing about the fact that this 11th District COFI index had been intentionally compromised, that is, manipulated. If my memory serves, I also recall that it was so compromised that for a period the market stopped utilizing it as a  benchmark. Could the same happen with Libor in the foreseeable future?

How interesting that under Frequently Asked Questions, the Federal Home Loan Bank of San Francisco provides the following disclaimer:

Does the Bank guarantee the accuracy of the cost of funds indices it publishes?
No. Although the Bank makes a good faith effort to be accurate in the calculation and publication of the COFI and other cost of funds indices it publishes, the Bank does not warrant, confirm, or guarantee the accuracy of the data it receives from its COFI Reporting Members, the accuracy of the cost of funds calculations, or the accuracy of the cost of funds indices as published.

The Bank does not examine the books and records of its COFI Reporting Members for this purpose, and the Bank expressly disclaims all liability that may arise from any use of the COFI or other index or the use of inaccurate data received from its COFI Reporting Members in calculating the COFI and semiannual cost of funds indices. In addition, the Bank expressly disclaims any liability to any person for any inaccuracy in any cost of funds index, regardless of the cause, or for any resulting damages. In general, the Bank will not revise or republish any COFI or any semiannual cost of funds index for any reason after the publication date.

Garbage in….garbage out… sounds a lot like the practices used in the carting business.

Twenty years from now, will another massive rigging scandal ensue? Unless there are very real changes within our financial regulatory framework, I would count on it.

Related Sense on Cents Commentary
Barclays Libor Scandal: Holding Regulators to Account
Barclays Libor Scandal: “Diamond Lied”
Barclays Libor Scandal: Who’s Really to Blame? 
Barclays Libor Scandal: When Did Manipulation Start?
Barclays Libor Scandal: How Big Will This Get?
Barclays Libor Scandal: Reports Regulators Knew; Time for Independent Investigation and Eliot Spitzer
Barclays Libor “Price Fixing”: Collusion Is Illegal. . .

Larry Doyle 

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • Jay

    “As a company, we now avoid London,” said David Kotok, who manages about $2 billion as chief investment officer at Cumberland Advisors Inc. in Sarasota, Florida.

    “It’s tarnished. Passing the buck to others, shirking responsibility and avoiding accountability characterizes the people at work there.”

    London Self-Regulatory System Proves Illusory

  • David

    Ah yes, the 11th DCOF. That brings back some memories. I bought and sold a few of those Sr./Subs in my days . . .

  • wallstreet69

    add to your list the MMD municipal bond rate….two guys in a room set pricing on an entire industry. no chance of moral hazard there!

  • Tom Foolery

    Are we to believe that Wall Street has never before been involved in rigging and manipulating markets?

    How quickly we can all forget about this one:

    Dealers Pay Up in Price Fixing Scam: Doubts Linger Over Billion Dollar Penalty

    Wasn’t this the start of Mary’s gig at NASD? Price fixing amounting to 2 cents a share? I can only laugh. The fix on spreads was at least 25 cents for the most liquid securities. So make 12 billion pay one. The Regulator was in on it. However, the NASD neither admitted nor denied the “allegations of collusion.

    The system is completely broke. Don’t think there is any fixing it.

  • bababa

    In the aftermath of the Barclays Bank Libor scandal (financial Hiroshima) and their greed and subsequent cover up tactics, we studied the future impact on the bank and its franchise in the next 6-8 months using the Monte Carlo method and the capital asset pricing model. This has been developed using variable analysis on a common measure of the volatility of its ongoing business, i.e. its beta–which is determined using linear regression. These have been applied to the latest audited Barclays Bank balance sheet, their Libor rate rigging scenario and inferences drawn with 95% accuracy. The result highlights the following 5 points:

    1. In the next 12 months, as its market standing and franchise has suffered, the Barclays Bank group will have to make a loan loss provision of USD 5.75 billion.

    2. Their combined exposure (including paper transactions) is USD 1.35 trillion which they need to unwind at the earliest and reconcile their financials/book of accounts within 24 months. Overall loan losses to be written off could be around USD 3.5 billion and thus their paid up capital will be affected.

    3. Their International trade, LC and LC confirmation business, correspondent banking business will reduce by about 40 % in the next 12 months as their price/rate quotation/covenants/IM will be seen with suspect.

    4. As a result of (3) above, their overseas operations will reduce (some businesses will have to close down) by at least 30 % globally. This will open up a new avenue wherein, in the next 24 months, their overseas business will very likely be acquired by 2 Chinese and 1 Australian banking consortium.

    5. The above points indicate that they will definitely need UK Government bailout well within a year. The UK government is already planning to nationalize the bank and make it a pure local British Bank going forward with an Australian as its head.

  • coe

    COFI – THE benchmark for most residential adjustable rate mortgages in the early years…as the numbers of thrifts dwindled due to consolidation out west in the 11th district, truth is there were only a couple of big banks whose mortgage rates drove the COFI calculation…and what about the Treasury auction scandal that precipitated the demise of Salomon Brothers, the once venerable bond kings of Wall Street…truth is, in the absence of a strong regulatory framework with enforcement teeth, human nature will lower itself to its basest instincts – what can I do to game the system to my own benefit? and how can I not get caught?

    or if I do, how can I rationalize it, sweep things under the rug by paying a simple fine and pleading “nolo contendere” shades of Agnew/Nixon in political history …good examples in all walks of life

    btw, pretty provocative crystal ball gazing by your reader bababa above! Wonder if he can call the presidential election?






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