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Tim Geithner, Fed Know Libor Is Useless, But Will Keep Using It For Taxpayer-Backed Bailouts Anyway

10/25/2012 03:23 pm ET | Updated Dec 25, 2012
  • Mark Gongloff Managing Editor, Business and Tech, The Huffington Post

It's a good thing we have all decided not to care about the Libor scandal, or else Tim Geithner and the Fed might be looking kind of silly right now.

The Federal Reserve and Tim Geithner's Treasury Department have let it be known unto the land that they are totally fine with continuing to use the London Interbank Offered Rate, aka Libor, in setting the terms of bank bailouts, writes Shahien Nasiripour of the Financial Times. This, despite the fact that Libor is as useless and tarnished as the napkin I just used to mop up some Chipotle black-bean juice off my desk (also, suck it, David Einhorn).

The Treasury and the Fed are choosing to ignore the recommendations of the special inspector general of the bailout program, the Troubled Asset Relief Program, Christy Romero (aka SIGTARP or bailout watchdog). She wrote in a report to Congress released on Thursday that Libor should be removed from the bailouts immediately.

"Continued use of LIBOR for TARP while it is broken, unreliable, and remains potentially subject to manipulation, undermines public confidence in financial markets and TARP and could put taxpayers at risk," Romero wrote, echoing comments she has made previously.

The Treasury Department and the Fed used Libor in setting bailout payback terms for the banks and for American International Group. After Geithner took over at Treasury, AIG's bailout terms were whittled down from an initial loan with a high interest rate to one based on Libor alone. He has told Congress that he didn't know how much the use of an artificially low Libor might have cost taxpayers. But it could be in the billions of dollars.

Though many banks have paid their TARP money back, there's still more than $6 billion in TARP-related loans to banks outstanding, according to Romero's report. These don't expire until 2015 or 2017, depending on the program. That's a lot of money and a lot of years to be relying on a flawed measure like Libor.

Libor is a benchmark lending rate used to set borrowing costs throughout the economy, along with hundreds of trillions of dollars' worth of derivatives contracts. It is based on numbers that a handful of banks self-report every day. The banks have incentives to manipulate the number, either to turn some extra profit on derivatives trades or to make their borrowing costs look low so investors won't freak out about them, or both.

And it looks like they have been manipulating it as hard as they can, early and often, a scandal that has still only just begun to unfold. Barclays has agreed to pay $450 million to settle Libor-fixing charges, and more than a dozen other banks in the U.S., U.K. and Europe are still under investigation. Lawsuits from wronged investors and borrowers have pushed the potential bank liability into many billions of dollars. Regulators on both sides of the Atlantic are trying to figure out how to fix or replace Libor. It has long been the standard benchmark for all kinds of loans and contracts, so it's going to be difficult to replace, but there are alternatives available already.

Treasury and the Fed told Romero they were just as worried as she is about Libor's reliability, but said essentially they were crossing their fingers that banks were reporting it correctly these days. But saying "here's hoping" is not a strategy.

So far, the Libor scandal is a little too confusing and murky to be "camera friendly," so has garnered little attention in the U.S. But it has been a bit of a liability for Geithner personally. He was in charge of the New York Federal Reserve when that top Wall Street regulator started hearing about banks manipulating Libor during the financial crisis, but chose to do little more than write a sternly worded memo to his counterparts in the U.K.

Geithner claimed that he first learned of Libor monkey business during the crisis, but others at the Fed had worried about Libor's reliability for many years. And Libor was a joke on Wall Street trading desks for years before that.

By now, Libor is a joke to everybody, but Treasury and the Fed will keep using it.

Update: In a letter responding to Romero, the Treasury Department says neither it nor the Fed have the authority to change the benchmark in TARP programs. It also says it worries changing the benchmark could harm taxpayers. It does say it will "continue to assess" whether any changes are needed, as regulators keep investigating and reforming Libor.

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