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On LIBOR - Sue Them All Or Go Home

Tyler Durden's picture




 

Despite BoE's Tucker telling us this morning that there is no need to look at any other market but LIBOR, it appears the world has moved on from this debacle of indication of anything. As we pointed out here, the 'stability' of LIBOR given everything going on around it is incredulous (whether due to the ECB's crappy-collateral standards-based MROs or the Fed's FX swap lines - since unsecured interbank financing is now a relic of the pre-crisis 'trust' era). Furthermore, as we discussed yesterday, the machinations of the LIBOR market and calculations (which Peter Tchir delves deeply into below) suggest that this not the act of a lone assassin suggesting quite simply that complaining or suing Barclays is redundant - any Libor-related suits (from the public or the government/regulators) must sue all the submitters or it misses the critical facts of the manipulation.

 

Via Peter Tchir of TF Market Advisors,

LIBOR is getting “Streakier”

LIBOR if anything is becoming less volatile.  Part of that is the fact that the Fed is at ZIRP and all banks are supported, but it is interesting to look at these streaks.  It is the number of days in a row that LIBOR changed by less than 1 basis point in either direction.  We are currently in a streak that has lasted almost 2 YEARS!  Yes, for 2 years now, we have not had a daily change in LIBOR of more than 1 bp.

Basically since the end of the financial crisis, LIBOR has been very “stable”.  Prior to 2009 it was unusual for LIBOR to be so stable.  I find the summer of 2008 particularly interesting.  I remember issues with the energy markets, with concerns over Fannie and Freddie, the fact that Bear Stearns had gotten to the point of needing to be bought, yet LIBOR remained very stable that entire summer.

Small Changes are the “norm”

Whatever “manipulation” was going on, in most cases LIBOR barely moves. In fact on more than 82% of the days, LIBOR moved by 1 bp or less and almost 92% of the time, the move was 2 bps or less.  2 bps on 3 month LIBOR is 0.005% of notional. On a $1 billion exposure, a change of 2 bps on the setting would mean the difference of about $50,000.  Not chump change, but worth keeping in mind.

The “BIG” Moves in LIBOR are concentrated around the Financial Crisis

The period of 2008 was particularly volatile.  But that was also true of all markets.  Massive swings in stocks and fixed income were the norm.  Policy after policy was put in place to calm credit markets and let’s be honest, to control LIBOR.  The Fed was working hard to make the bank funding problem go away.

The big moves in 2007 started in August when problems at the big banks became brutally apparent, but continued throughout the fall as the Fed aggressively pushed Fed Funds down and removed the “taint” from using the discount window.  By May of 2009, the crisis had subsided and the big moves in LIBOR were largely reactions to that.

Off-hand, I’m not sure what drove the bigger moves in 2003 to 2006, but I suspect that there are reasonable answers to those based on world events and central bank activity.

The next chart looks at when those moves of 3 bps or greater occurred.  2008 sticks out like a sore thumb.

 

2 Distinct Periods

I think the problems with LIBOR will break down into 2 distinct phases. 

The “Pre-Financial Crisis” period had consistent but small amounts of volatility.  I think this period will pose problems for “investors” trying to get money, but be easy for “legislators” to go after the banks.  Most of the damaging e-mails from the Barclay’s transcript seem to focus on the pre-crisis period.  Dealers (and accounts) trying to push LIBOR either way for a basis point or two.  We don’t know the details yet, but I suspect that we will find out other banks were doing the same as Barclay’s.  The nature of the LIBOR calculation almost necessitates collusion as 1 bank alone has a trivial impact.  My guess is we will find that there is no particular pattern to the “manipulation”.  That some days the attempt was to push it higher and some days it was to go lower and that there may have even been competing “coalitions” on certain days.  It will revolve around the specific roll risk on a particular day for any given institution.

The big banks are far more likely to have big “roll” positions on any given day where moving it up and down a couple bps for those days makes a meaningful difference.  It looks bad and is bad and people will lose jobs and it will change how LIBOR is produced over time, but I still think the ability to win significant lawsuits against banks during this period will be difficult.  More on that as we finish our more detailed analysis.

The “Financial Crisis” period had the most volatility.  It started in 2007 and didn’t really finish until 2009.  That was basically the time frame during which fears of bank credit risk was high.  There were times when the only source of short term money for banks was depositors and the central banks.  This period of time may be problematic for everyone.  In short, it looks as though a big effort was made to “pretend”’ LIBOR was low in spite of the fact that banks weren’t willing to actually lend money to each other anywhere near those levels (trying to find out what interbank trading was occurring, if any, as that would be highly useful for determining how valid LIBOR is).  The entire market was watching LIBOR for signs that a bank was in deep trouble.  “Bear raids” were the norm, and there was no better way to attract one as a bank than submitting a very high LIBOR rate.  The push to get LIBOR down was all about trying to calm markets.  Banks themselves may have been losing money because of low settings, but wanted low settings in any case, because the alternative was potential nationalization.

This is what makes 2008 potentially more difficult.  Banks may not have profited.  There was no real lending.  The central banks and politicians (at least those with any sense who weren’t short the market) were happy to see LIBOR come down.  If the pattern was consistent, it helped all borrowers.  It didn’t help lenders.  What happens if all banks lied?  What happens if banks themselves were hurt on lots of trades?  Can LIBOR be restated?  The construction of LIBOR is an issue.  The question is potentially vague, and the BBA relies on bank regulators to regulate the submissions, yet it is the BBA that publishes them.  I think this is where we might see all non-bank floating rate lenders suit.  They were receiving less income than they otherwise would have.  That problem is potential massive and dwarfs (in my opinion) the claims around derivatives since it is far easier to prove and will be owned by some investors the jury would sympathize with. 

Who Does a Lender Suit?

Say you lent $1 billion to various companies, and it turns out that LIBOR was off by 50 bps.  To be off by 50 bps, you would need to sue all of the contributors.  Each contributor is only worth a fraction of the total, since it is an average.  I’m not sure how the fact that some get kicked out and don’t count in the average would play into it.  In any case, I think all contributors would have to be sued as a group rather than individually to get an effective result.

But the banks didn’t benefit.  If LIBOR should have been 2% but was only 1.5% it is the company that benefitted.  The lender is suing the bank for setting the wrong rate, but it is the borrower who benefitted.  Can the banks use that as a defense?  Can they go and suit the company to get them to pay the higher rate?  I highly doubt that.  That to me is the key, if the banks can be made to pay the lenders this gets really ugly.  The argument would be that the banks set the rate low so are responsible.  The borrowers would claim innocence so couldn’t be sued.

Can LIBOR be systematically restated?  What if LIBOR was restated, would lenders then have to sue the borrowers individually?

I think the pre-crisis period is relatively tame.  Small moves in both directions will likely be hard to find anyone who was consistently harmed, or harmed enough to justify the legal costs.  Especially since you cannot really sue just one bank and the size of any potential manipulation seems look in the pre-crisis era.

The post crisis era seems more likely that a consistent pattern was in existence, though it is unclear whether the definition of LIBOR is weak enough that a bank could defend their actions by showing an absence of trading and their own “rationale” for why their LIBOR met the definition.

Why You have to Sue them All

Again, I haven’t looked closely at bank by bank submissions, but it looks like in the pre-crisis era, banks attempted to get small moves in their favor in either direction as they needed.  Here is why even finding one bank isn’t enough.

Currently US LIBOR is set by 18 banks.  Each bank provides a “submission”.  The 4 lowest and 4 highest are thrown out and LIBOR is the average of the other 10 (the number of contributors and who contributed has changed over time).

For now let’s assume that there is a way to verify what the “real” rate for any bank is.  Remember, the question is where they “think” someone would lend to them.  If they are busy borrowing money from their friendly central bank and are too scared to even ask another bank, it is possible that it will be very hard to prove they are “lying” or by how much they are “lying” by.  That is another separate question, and for now we will just assume, the amount of the “lie” is known.

We will look at a hypothetical effort to move rates lower (the same would be true for moving rates higher).

There are 4 basic scenarios if 1 bank is “lying”:

  • The “real” level would already put them in the group being discarded.  Then the lie had no impact as their “real” level would not have been included in the setting.
  • The “real” level would have put them in the calc, but the lie kicked them out.  The impact would be the difference between their “real” rate, and the rate submitted by the 4th lowest dealer (divided by 10).  The 4th lowest dealer would be included since the “lie” rate was lower.  Depending on the “real” rate vs 4th lowest rate, the impact would be between 0 and the full “lie” (divided by 10).
  • Both the “real” and “lie” level would be included.  The full differential (divided by 10) would have impacted the LIBOR setting.  Since they would have been included with their real rate, and were still included with their lie rate, the full differential would have impacted.
  • The “real” rate would have been excluded, but the “lie” rate was included.  Here the impact is the difference between the “lie” rate and the rate the 14th highest rate submitted (divided by 10), since that dealer was no longer going to be counted.  So again, the impact could be between 0 and the full differential (divided by 10) dependent on what the 14th highest fair submission would have been.

So on any given day, the impact would depend on what the other 17 dealers submitted.  All, none, or only a portion of the “differential” might impact the calculation.  So even if you can quickly prove that a bank was “lying” on the submission (which may not be easy to do), you still need to determine if that lie had an impact based on what other dealers submitted that day.

Here is an example from a few days ago.  This is purely for illustrative purposes.  I am assuming every one of these rates is a “real” rate.  The point is to show what impact a “lie” would have.

 

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Mon, 07/09/2012 - 13:23 | 2599058 idea_hamster
idea_hamster's picture

The impact is how often a given bank, like BCS, falls in the top tier that gets trimmed off -- and by how much.

Steady LIBOR is a function of the calculation method that is designed to disregard the outliers.

But if your bank is constantly a high-risk outlier, it's a sign that the other club members know you're teetering -- not good, can't have that.

If we had a history of who was in the top trimmed section, THAT would be of interest!

Mon, 07/09/2012 - 13:22 | 2599066 DavidPierre
DavidPierre's picture

It Won’t Be Too Long Before The Gold/Silver Market Manipulation Scandal Goes Mainstream … BIG TIME!

By: Bill Murphy

http://news.goldseek.com/LemetropoleCafe/1341831900.php

Mon, 07/09/2012 - 13:29 | 2599088 Temporalist
Temporalist's picture

Ned Naylor-Leyland on CNBC July 9th:

Gold May Have Been Manipulated Like Libor: Expert

"It is effectively an intervention in two ways; one would be the fact that for central banks gold and silver going up doesn't make their currency look any good and secondly a number of the big commercial banks have very large short positions which they like to manage and make easy money from," Ned Naylor-Leyland, investment director at Cheviot, told CNBC.

http://video.cnbc.com/gallery/?video=3000100465&play=1

Mon, 07/09/2012 - 14:03 | 2599204 DogSlime
DogSlime's picture

Don't worry. 

If there has been any misbehaviour then the SEC and FSA will be right on it.  The guilty will be punished just like all the others have since 2008.  Our financial regulators are superb - nothing gets past them and they always "get their man."

It's nice to know that's happening in some alternate universe.  Shame it's not this one :(

Mon, 07/09/2012 - 14:04 | 2599205 CCanuck
CCanuck's picture

Good for Ned, held his own there, he speaks with a calm confidence.

+1 for posting link

Mon, 07/09/2012 - 13:22 | 2599067 tony bonn
tony bonn's picture

"..any Libor-related suits (from the public or the government/regulators) must sue all the submitters .."

precisely and this includes the fed and its tbtf banks....

Mon, 07/09/2012 - 13:24 | 2599077 Snakeeyes
Snakeeyes's picture

Are you suggesting sueing the Federal Reserve and Bank of England too? Because LIBOR tracks Fed Funds rate very closely.

Or are you pulling an Obama on waivers?

http://confoundedinterest.wordpress.com/2012/07/06/libor-fixing-and-the-fed-funds-target/

Mon, 07/09/2012 - 13:24 | 2599078 Kitler
Kitler's picture

Nothing to see here but 'the invisible hand of the market' at work...

Mon, 07/09/2012 - 13:35 | 2599104 Mercury
Mercury's picture

Go home.

Mon, 07/09/2012 - 13:37 | 2599116 john146
john146's picture

global racketeering.....

 

Mon, 07/09/2012 - 13:39 | 2599120 world_debt_slave
world_debt_slave's picture

but, but, it was necessary to save the world. Tucker told me so.

Mon, 07/09/2012 - 13:41 | 2599128 john146
john146's picture

just remember who wins in the end....there is no stopping what is coming and there will be nowhere left to hide

Mon, 07/09/2012 - 13:45 | 2599139 MachoMan
MachoMan's picture

First, as a matter of bookkeeping, the verb is "sue", the noun is "suit".

Second, yes, if a party doesn't have any damages from a transaction, they'll likely not have a cause of action.  Certainly, for breach of contract, for example, damages are necessary.  Now, this sometimes flies out the window when particular acts break laws.  Sometimes, laws carry statutory damages for performing a particular act...  and, will often throw in attorneys fees for the victor.  My guess is that there are plenty of statutes at play here...  whether or not any of them carry inherent penalties for failure to strictly adhere to them is another question...  my general gut feeling though is that if a party benefitted from the libor manipulation, that party is shit out of luck to sue...  (why would they want to sue anyway?)[as an aside, is the tangentially benefitting party at risk of any liability via conspiracy, etc.?].

Practically speaking, the better question is who was the other party...  the loser...  we're talking about zero sum games here.  So, for every winner...  Show me the loser and I'll show you a prospective plaintiff.  If it's the same company that manipulated libor, then all the more reason it shouldn't have been bailed out (fucking retarded).  If not, then it needs to start at least nibbling at the carcas before the big animals feast.

Third, the limits on punitive damages (BMW and its progeny) are probably out the window on a case like this.  The SCOTUS' limitations can get thrown to the wolves when damage is particularly bad and when it affects a lot of people...  sounds like check and check.

 

Mon, 07/09/2012 - 14:13 | 2599208 Ned Zeppelin
Ned Zeppelin's picture

During the 2004 and after era, it was the SWAPS that were generated from the LIBOR rates that are the key here. The normal loans based on LIBOR are not the issue - the loans were originated with adjustable rates linked to LIBOR, but then you were sold (heavily sold) a SWAP to fix your interest rate, but the SWAP also provided for a penalty to escape. The downward turn of rates due to ZIRP made the fixed rate SWAP extremely expensive to exit (for instance, if you needed to sell a building to raise cash) because the cash could not invested at a higher rate.  That is where the problem is, or at least one of the liability targets.

Then think of all of the derivatives that spun off of those transactions and you have your plaintiffs. 

Mon, 07/09/2012 - 14:38 | 2599344 Antifaschistische
Antifaschistische's picture

abolish LIBOR.

Full Transparency of all bank-to-bank ACTUAL lending rates and volumes.

PUT IT ON THE WALL!!

Mon, 07/09/2012 - 14:40 | 2599357 newworldorder
newworldorder's picture

The problem is - RULE OF LAW - in Western Democracies.

Most people believe that they still have and are governed by this rule of law..  Governement and Financial elite know that rule of law has been usurped, but the illusion of having it must be maintained. Thus the struggle to maintain this illusion at all costs.

The emperor is indeed naked. Once this is aknowledged and accepted by the masses then "all hell will break out." Maintaining the illusion of rule of law is the only game left to play.

Mon, 07/09/2012 - 14:44 | 2599369 AnAnonymous
AnAnonymous's picture

What rule of law?

Since their inception, US citizens have been profiting from selective disrespect of the so called rule of law.

It has not changed since.

Mon, 07/09/2012 - 15:06 | 2599468 rsnoble
rsnoble's picture

Cool ill be waiting for the lawyer to show up in my drive in his million dollar lambo to hand me my 50cent class action lawsuit check while the jailed bankers are basking on Fantasy Island with 10,000lb fruit bowls everywhere. 

People are getting really tired of this bullshit exp since no doubt the US is probably the biggest one in all of this and you can go to jail for life in this country for stealing a fucking candy bar 3x.

Tue, 07/10/2012 - 09:12 | 2601692 dizzyfingers
dizzyfingers's picture

 

Where Was Auditor PwC When Its Client Barclays Gamed Libor? Explaining its $450 million settlement with U.S. and U.K. regulators, Barclays said it had "inadequate" controls and "had not anticipated the increased risk around the Libor process." Auditor PricewaterhouseCoopers has been negligent in its duties as well.

PwC agreed to the most minimal disclosure of Barclays' potential settlement in the annual report released in March. Barclays "attempted to manipulate and made false reports concerning both benchmark interest rates to benefit the bank's derivatives trading positions by either increasing its profits or minimizing its losses," according to the Commodity Futures Trading Commission. PricewaterhouseCoopers missed, or maybe looked the other way at conduct that was "regular and pervasive."

The CFTC enforcement order says Barclays based its Libor submissions on the requests of Barclays' swaps traders, who were attempting to influence the official published London interbank offered rate and the profitability of their own trades. In addition, certain Barclays swaps traders "coordinated with, and aided and abetted traders at certain other banks to influence the Euribor submissions of multiple banks, including Barclays." Barclays also systematically suppressed its submissions to the Libor committee regarding its borrowing costs to mitigate perceptions of its weakness during the 2008 crisis.

PwC could have caught the faults twice. The auditor should have identified and warned shareholders and the public about increased risk at Barclays. An audit firm has an obligation, according to standards enforced by the Public Company Accounting Oversight Board, the profession's U.S. regulator, to audit disclosures. Generally Accepted Accounting Principles and International Financial Reporting Standards require disclosure of information about risk. (Barclays is subject to the latter set of rules.) If disclosures are materially incomplete or inaccurate, an auditor should not issue a clean opinion.

The "management discussion and analysis" of results for a financial institution must include discussion of: liquidity; capital resources; results of operations; off-balance sheet arrangements; and contractual obligations. Although auditors' obligations are more limited here, the auditor should read this information and consider whether it, or the manner of its presentation, is materially inconsistent with information appearing in the financial statements.

Second, when a bank must comply with Section 404 of the Sarbanes-Oxley Act (and Barclays must, despite being a foreign entity, since its American Depository Receipts trade on the New York Stock Exchange), the auditor expresses an opinion on the effectiveness of the company's internal control over financial reporting. PCAOB's Auditing Standard No. 5 says, "When auditing internal controls over financial reporting, the auditor may become aware of fraud or possible illegal acts. In such circumstances, the auditor must determine his or her responsibilities."

Controls over values created using models, third-party pricing services, and use of market inputs are supposedly supported by elaborate compliance systems to make sure valuations meet accounting standards. Basic assumptions used to assign values such as benchmark interest rates should not be vulnerable to manipulation or collusion. Banks must comply with legal and regulatory requirements to ensure the integrity of data critical to the functioning of the capital markets.

According to the regulators, Barclays had no specific internal controls or procedures, written or otherwise, regarding how Libor submissions should be determined or monitored, and Barclays also did not require documentation of the submitters' Libor determinations.

The CFTC order requires Barclays not only to beef up its compliance processes but to "take on a role as an advocate for increased oversight for the industry," according to the Financial Times. Auditor PwC gave Barclays – along with JPMorgan Chase and MF Global – clean opinions on internal controls over financial reporting while we know now, from regulators' disclosures, that those controls were seriously deficient.

More than a dozen other banks are under investigation by U.S., Asian and European regulators for collusion in setting interbank lending rates. It will be interesting to see if KPMG, Ernst & Young and Deloitte's banking clients also manipulated Libor – as Barclays suspected – and if those banks also allowed derivatives desks to set the rates.

If so, Barclays has a big job ahead as industry advocate for being good.

Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.

Regulation & Reform Risk Management Comments (5) One might as well ask where were the regulators? Why not routine checks of the proper segregation of responsibilities in such important functions as index calculation and rate setting? Posted by gtownsend | Friday, July 06 2012 at 3:00PM ET @gtownsendYou make a valid point. However, auditors are much closer to the action, more often than regulators. In the largest banks, the audit is a year-round process. Auditors are the first line of defense for shareholders against management self-interest, after internal audit and the Audit Committee of the Board of Directors. Posted by Francine McKenna | Friday, July 06 2012 at 9:19PM ET Bank's are setting thenself up for more regulations and higher outside audit fees.

The Internal Audit Department should have reviewed the theory behind how Libor was being determined and monitored its movements.They should have done the same for the Morgan/Chase Whale Theory. However, today the Banks Internal Audit Department's are being used a management consultants and not as safeguards/police for the Audit Commitee and the Shareholder. The Board of Directors and Shareholders now must rely on the Outside Auditor that depend on management and the internal auditors review of internal controls. However, they are relying on the same management that is responsible for the controls and have the most to gain with loss controls.Lastly you have the Board of Diectors/Audit Committee. They are retired accountants and bankers that are serving at the grace of management and collecting their monthly pay from management. They are protected by Insurance Bonds and they only can be held accountable for what the Internal Auditors or Outside Auditors present to then in Black and White during the Audit or Board Meeting. This is why the Minutes do not included everthing talked about.Lastly the regulators depend on all the above and review all their reports and minutes and on that they base their decision.It's the Blind leading the Blind. The Buck does not stop here. Posted by Krooton | Friday, July 06 2012 at 9:41PM ET @KrootenYou have explained the current corporate governance dilemma. False assurances all around. And shareholders have been held back by the proxy process. Very difficult to get information or voice heard. Posted by Francine McKenna | Saturday, July 07 2012 at 9:14AM ET http://www.americanbanker.com/bankthink/where-was-pwc-when-barclays-gamed-libor-1050689-1.html Related Links In Libor Scandal, Prosecutors Need to Think Criminal Giving the Lie to LIBOR How to Break up the Big Four Accounting Oligopoly How to Put More Distance Between Banks and Their Auditors Web Seminars The New Subprime Definition: Who is subprime now? How much subprime is in your portfolio?
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