Thursday, July 5, 2012

LIBOR Manipulation

By Tim Dulaney, PhD and Tim Husson, PhD

An ongoing investigation into the manipulation of LIBOR has exploded recently with the revelation that Barclays was actively manipulating LIBOR since 2005, possibly at the behest of Paul Tucker (a leading candidate to become the next governor of the UK central bank). As evidenced by several forms of electronic communication, some employees were submitting false data to boost profits.

Such accusations of LIBOR rate manipulation are not new. In 2008, the British Bankers Association (BBA) accelerated their investigation of LIBOR discrepancies and a study performed by Wall Street Journal analysts indicated that several banks under-reported borrowing costs and, as a result, overstated the health of the banking system.

LIBOR is an acronym for the London InterBank Offered Rate. The rate is supposed to be indicative of the cost of borrowing between leading banks and is considered to be one of the most important benchmarks of short-term interest rates. The leading banks report their best estimation for their cost of borrowing and the rates are then calculated and published as an average of these reported rates by Thomson Reuters on behalf of the BBA. The rates are calculated daily for various maturities ranging from overnight to one year and in ten currencies.

LIBOR is the common thread running through both everyday credit (such as mortgage payments or credit card payments) as well as exotic financial derivatives (such as interest rate swaps, corporate debt and forward rate agreements). As a result, LIBOR determines the interest accrued on literally hundreds of trillions of dollars of transactions.

Each currency has a panel of several leading banks, selected annually, that are representative of the London money market. LIBOR rates for each currency are then determined by taking the submissions from the panel members, throwing out the lowest and highest quartiles and then taking the average of the middle two quartiles.

As a result of the way LIBOR is calculated, it would take widespread under-reporting of borrowing costs for the rate to be effected. According to the Wall Street Journal, "Barclays is the only bank so far to resolve Libor-fixing allegations, but roughly a dozen banks have acknowledged being under criminal or civil investigation in various countries in the matter." Up until 2008, Barclays had been submitting some of the highest borrowing costs and only after the suggestion of Mr. Tucker did Barclays begin submitting lower rates, more in line with the other banks on the panel.

As a result of this revelation, Barclays has agreed to pay a $453 million fine and several of the bank's executives (including the CEO, COO and chairman) have resigned. Barclays former chairman, Marcus Agius, has become a focus of the investigation since he was also serving as the chairman of the BBA.

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