Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Thursday, 12 July 2012

Why Bob Diamond is winning in the LIBOR scandal


When one’s position is about to be overrun by the enemy there is no point in digging in and becoming a martyr. Lob a few grenades, create a smokescreen and swiftly retreat to fight another day. Bob Diamond, the master general, has done just this.

The politico-regulatory establishment had been waging war against him for quite some time. His aggressive “American investment banker” behaviour and intemperate remarks (“there was a period of remorse and apology [for banks]; that period needs to be over.”) did not endear him to them. Therefore it was only a matter of time before he was outflanked and defeated.

Despite all odds he managed to hold out for a long time until the current LIBOR miscalculation. By racing ahead of other banks to settle he allowed himself to be isolated and outflanked. His position became untenable when even Agius’s suicide mission did not halt the attack. But instead of shooting himself quietly in a bunker, he lobbed a few grenades in establishment’s direction and made a run for it.

It proved to be a masterful strategy. As BoE’s Tucker was knocked off by the blast, attention shifted to the LIBOR shenanigans which took place during the credit crisis in 2008. During the period when Lehman Brothers failed and the banking system was about to vapourise, Barclays admitted to submitting artificially low LIBOR rates. As everyone fixated on this period, it led to two great results for Diamond, Barclays and other banks.

The first result was intended because lower LIBOR submissions during the crisis are more easily defended. The argument is that lower submissions were made by most other banks too and enabled the banking sector to stave off collapse. In times of crisis, saving the system trumps all other concerns. Therefore it is not much different from the subterfuge indulged in by the BoE to save RBS and HBOS. Indeed Diamond implicitly said as much to the Treasury Select Committee chair: “Barclays opinion was that those other banks’ submissions were too low given market circumstances…Even taking account of the abnormal market conditions at the height of the financial crisis, and that the motivation was to protect the bank, not to influence the ultimate rate, I accept that the decision to lower submissions was wrong.” (Emphasis mine)

Moreover, the definition of LIBOR states (emphasis mine): “The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11.00am London time.” This is not the same as “The rate at which a bank has borrowed funds today from the interbank market”. Therefore artificial submissions can be defended on two grounds:
  1. Vacuous truth: There was no market and no interbank offers in that period therefore the LIBOR submission was correct (it was a best guess estimate).
  2. Accurate estimate: The bank estimated that it could borrow funds around that level prior to 11AM but never borrowed any. Therefore it was impossible to verify whether the submission was correctly representing actual cost of funds or not. The accuracy of submission is now a matter of opinion and cannot determine whether the rate was right or wrong at that time. (Note the 11AM condition is a loophole in itself as costs of funds can change during the day so even if borrowing was done on the interbank market after the submission at a different rate, the two are not strictly comparable). Barclays cannot use this excuse since it has admitted to lower rate submissions but other banks can.
The second great result for banks is that Diamond has succeeded in dividing the enemy’s forces. Diamond’s smokescreen of Whitehall involvement led to Osborne’s ill-judged and politically motivated attack on Ed Balls. This has created a circus which diverts attention from the real issue.

The issue which Barclays and other banks want to bury is the LIBOR manipulation during 2005-2009. The way LIBOR works it is impossible for one bank to manipulate the rate alone. Rate submissions in the top and bottom quartile are discarded and LIBOR is set based upon the average of the remaining. Eg. If there are 16 banks contributing rates then the four highest and lowest submissions are discarded. The average of the remaining 8 is the LIBOR rate. Therefore if Barclays submitted rates which were too high or too low, they would be discarded and thus not influence the actual LIBOR setting. To achieve what Barclays’ traders asked (box) would require banks to cooperate.

“Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the libor fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot." (September 13, 2006, Senior Trader in New York to Submitter)”
"For Monday we are very long 3m cash here in NY and would like the setting to be set as low as possible ... thanks" (December 14, 2006, Trader in New York to Submitter)”

Furthermore, it is unlikely that the practice suddenly started in 2005. If collusion has been going on for a long time then Diamond’s defence does not hold that “inappropriate conduct was limited to a small number of people relative to the size of Barclays trading operations, and the authorities found no evidence that anyone more senior than the immediate desk supervisors was aware of the requests by traders, at the time that they were made”. This standard ‘few bad apples’ defence has worn thin due to the rate at which bad apples are being discovered.

Apart from the potential to still implicate senior echelons of management, the LIBOR scandal is also going to lead to civil and criminal lawsuits. And it is this 2005-09 period of manipulation which is the most damaging since it is exceedingly hard to defend. It is clear that customers, be it municipalities, funds or individuals, were defrauded of their money through these acts. Since derivatives are a zero-sum game, a bank’s gain is the customer’s loss.

At the moment the threat is being realized in the US even as the UK goes off on a tangent. Banks’ behaviour infringes the Sherman Act and possibly the RICO (Racketeer Influenced and Corrupt Organisations) Act. The former may not be considered that big a deal since banks have become accustomed to lawsuits and financial penalties (after all it is the shareholders’ money). But the potential of criminal convictions under RICO will lead to quite a few palpitating white collar gentlemen.

It is this American advance that banks will find difficult to halt. The British threat seems to have been largely neutralised by Diamond despite the Serious Fraud Office jumping into the fray. He has done Barclays and other banks a great service by confounding the advancing British forces and sowing dissension in their ranks while aggravating their outrage (A 4th of July gift to himself?). Even in retreat he has sought to capture the moral high ground by forgoing a ₤20m bonus. Such stratagems win grudging admiration. Great generals are seldom paragons of morality but war and finance are both immoral endeavours.


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