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Mark Sunshine

Mark Sunshine

Posted: March 24, 2011 05:22 PM

Banking's Newest Scandal: Alleged Price Rigging

Should banks be allowed to form cartels that manipulate price or is price fixing as illegal on Wall Street as it is on Main Street?

Those issues are about to be decided by prosecutors and courts in connection with the banking industry's newest scandal -- the alleged LIBOR price fixing and collusion cartel.

Media sources have reported that investigations have started in the U.S., U.K. and Japan by the SEC, CFTC, Department of Justice, Japan's Financial Supervisory Agency and Britain's Financial Services Authority. This multinational investigation is looking into whether LIBOR was manipulated by a group of banks that belong to the London based British Bankers Association or BBA. Investigators are reportedly focusing on the 2006 to 2008 time period which includes the peak of the financial crisis.

The investigation apparently includes most of the industry heavyweights including JP Morgan Chase, Bank of America, Citigroup, Deutsche Bank, West LB AG, Barclays Plc, Lloyds Banking Group and UBS.

LIBOR is short for the London Interbank Offer Rate and is supposed to be "the rate at which banks borrow money from each other each day." LIBOR is published by the BBA every London banking day and is globally used as an index rate of interest for an estimated $350 trillion of loans and financial products.

Conventional wisdom states that LIBOR is "fair" to both borrowers and lenders because it is a market-based interest rate. But, if LIBOR was manipulated then conventional wisdom is very wrong.

Every day the banks which set the LIBOR rate telephone into the BBA a set of interest rates that they claim they could have borrowed at in the interbank market that day. The rates aren't actual borrowing rates, but rather estimates of what these banks could have borrowed at if they had wanted to. The rates are complied by the BBA into an average with the highest and lowest LIBOR quotes eliminated from the calculation.

The BBA system for setting LIBOR lacks many of the safeguards that the financial community takes for granted. For example, no one can be sure that the published LIBOR rates have any basis in fact because there is no identifiable and verifiable audit trail from real market data to the BBA daily announcement. There is no realistic way to know if banks and bankers are talking to one another, or otherwise signaling each other, before the LIBOR estimates are called into the BBA. And, there no effective and strong independent verification that Chinese walls are preventing information about LIBOR from leaking to proprietary trading desks before being published by the BBA. Needless to say, it's a big trading advantage to know what some banks called in as their LIBOR estimates, and therefore the general direction of LIBOR, before it is announced to the public.

In 2008 the BBA came under intense pressure to reform. However, the BBA rejected calls for a fully transparent and verifiable process and went instead with modest changes to the LIBOR rate setting procedure.

The integrity of LIBOR is not a new topic of interest for me. In 2008 I wrote seven articles on the topic which questioned how LIBOR was set and advocated an immediate investigation into the matter. Some of the articles include correspondence from the BBA to me defending its position and questioning my analysis. I hate to say "I told ya' so," but...

Current published reports suggest that investigators are most focused on 2008, a period of time when it is thought that banks manipulated LIBOR downward to hide funding problems. The press almost makes it seem like understating LIBOR is a kind of victimless crime -- after all, if banks reduced LIBOR that means consumers and businesses benefited because they paid less in interest than they would have paid if LIBOR had been honestly reported.

However, there are two sides to every transaction and if someone got an unanticipated benefit from a rigged LIBOR rate, then someone else took it on the chin and was unfairly short changed. An artificially low LIBOR rate would have hurt lenders, investors and savers. Victims include retirees and other individuals who invested their cash savings in mutual funds that purchased LIBOR indexed instruments would have been hard hit by the alleged downward LIBOR manipulation.

I have a lot of trouble with the idea that LIBOR was only manipulated downward. After all, how hard would it have been for LIBOR setting banks to push LIBOR up a little to juice their loan portfolio earnings. On $350 trillion of debt, every fraction of a percentage point of upwardly manipulated LIBOR is meaningful. Overcharging consumers, only a little bit, adds up quickly when it includes all consumers.

This is yet another "moment of truth" for the Administration and Congress. Are banks subject to the same anti-trust and price fixing laws as other companies? And, if so, what should the penalties be for forming an illegal cartel that engages in price fixing?

I already know the answer to the question. The law should apply equally to all companies and in all industries. The penalties should be the same if it is a bank that illegally fixes prices or a manufacturer that colludes with its competitors.

I think that anti-trust and price fixing laws are there to protect the integrity of the economy -- they are there to protect the interests of the many from being abused by the interests of a very few.

I know that the LIBOR scandal is esoteric and hard for most people to understand. But, what is easy to understand is the idea that banks that beg for free markets can't then use their market power to form an offshore cartel designed to undercut the integrity of the very markets that they want free.


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