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Geithner’s LIBOR Pains – Part II



September 07, 2012 – Comments (0)

Board: Macro Economics

Domine Dirige Nos ("O Lord Direct us"), motto of City of London,

The Center of the International Money Market

What a lovely motto for the Mecca of high finance, London, the city that determines the global lending rates for ten currencies and 15 loan durations, known as the London Interbank Offered Rate (LIBOR). It seems strange that this lending benchmark is set in London and not New York. After all, the U.S. and not the U.K. has dominated the financial world since the end of World War II. Since Britain failed to reestablish the pound as a major international currency after the war, says Professor MacKenzie, British banks started to increasingly “lend, borrow and accept deposits in US dollars (‘eurodollars’, as they came to be called). The Bank of England overcame its initial anxieties and came tacitly to support the eurodollar market, and the [U.S.] administration inadvertently encouraged it by trying to stem the flow of dollars overseas. Eurodollar operations conducted in London allowed US banks to circumvent the new controls. The result was that London became – and in many ways remains – the centre of the international money markets.”[1]

In the early 1980s banks and hedge funds increasingly traded the newer financial instruments, such as options, based on loans. To established a standard method to determine what a bank would charge for a loan in the future, the British Banker Association (BBA) worked with the Bank of England and, after some trial and error, established a panel of 16 banks who would submit a hypothetical number at which they thought they could borrow from one another. The average computed number, after eliminating 25% of the top and 25% of the bottom numbers, is the London Interbank Offered Rate, supposedly reliable and difficult to manipulate. In 1986 the LIBOR index began being used officially and is now the global benchmark for lending with about $800 Trillion dependent on it worldwide.

The evolving LIEbor investigation

Evidence in London is mounting that there were many wayward London souls who left the righteous path, not only bankers but possibly those in highest government positions. During the period under intense scrutiny, roughly 2007 to 2009, bankers contributed fudged numbers to LIBOR as Barclays’ staff admitted. Did they act with the knowledge and perhaps encouragement of the Bank of England (BoE), itself under the pressure from Whitehall? During his testimony before Members of Parliament (MPs), Mr. Diamond, last CEO of Barclays, made it appear that the deputy governor of the BoE, Paul Tucker, had given Barclays a “nod and wink” to reduce its submissions to the LIBOR Panel. The record of Mr. Diamond’s conversation, “sent in an email to the then Barclays chief executive John Varley and copied to the co-head of the investment bank Jerry del Missier - describes how Tucker had received calls from ‘a number of senior figures within Whitehall’ to question why Barclays' submissions were higher than rivals.” Appearing before HM Treasury select committee on July 9 of this year, Mr. Tucker rejected any suggestion that government ministers had pressured him to encourage banks to manipulate LIBOR. He also stated “the Bank of England was not aware of LIBOR manipulation, or any allegations of dishonesty.”[2] Submitted emails between the BoE deputy governor Paul Tucker, cabinet secretary Heywood who questioned the reliability of LIBOR, and Barclays’ Mr. Diamond do not confirm that either the BoE or Whitehall condoned or encouraged submitting lower LIBOR numbers. They do, however, mention planned follow-up conversations. So far, no phone records, if they exists, have been made public. The Guardian has a whole series of related LIBOR articles and videos of interrogations, listed in the right-hand margin of the online edition linked above, for those interested in the nitty-gritty of U.K. hearings and original documents.

Paul Tucker’s protestations the BoE was not aware of LIBOR manipulation are difficult to believe when reviewing the Bank of England’s PDF entitled Correspondence between the Bank of England the Federal Reserve Bank of New York and the British Bankers’ Association. In May 2008 then President of the Federal Reserve Bank New York (FRBNY), Timothy Geithner, who must have known about LIBOR manipulation, spoke to Mr. Mervyn King, Governor of the BoE, when they met in Basel. A few weeks later Mr. Geithner emailed Mr Knight, copy to Mr. Tucker, his six Recommendations for Enhancing the Credibiity of LIBOR. What Mr. Geithner, known in private to speak his mind, said to Mr. Knight when they met is not known. It was probably more candid than his sober, dry recommendations, composed undoubtedly under the eagle-eyes of Fed lawyers and with potential future lawsuits in mind. Mr. Geithner’s first recommendation is to “[s]trengthen governance and establish a credible reporting procedure. To improve the integrity and transparency of the rate-setting process, we recommend the BBA [British Bankers Association] work with LIBOR panel banks to establish and publish best practices for calculating and reporting rates, including procedures designed to prevent accidental or deliberate misreporting.”[3][Emphasis mine]

The second reason for doubt is the email of June 3, 2008, sent to Mr. Tucker from Angela Knight, the public face of the U.K. banking industry and then boss of the powerful lobbying group, the British Bankers Association (BBA) under whose auspices the daily LIBOR rates get published. “The voice of banking and financial services,” as it calls itself, represents over 200 banks; its board is made up of twelve senior executives, most of them from banks too big to fail and who also submit their estimates of interbank lending rates The text of Ms. Knight’s email, almost reproduced in its entirety, reads as follows: “Thank you for the call. Changes are being made to incorporate the views of the Fed. There is no show stopper as far as we can see. ... Regarding your comments that the FSA [the British watchdog, the Financial Services Authority] should be out and other central banks in - all done. Timing is complicated. If it leaks we will have to go, and if it does not then we will hold off until thursday. Unfortunately this is in the hands of others. I have spoken to the CEOs and made people sign confidentiality agreements, but a you know there are a lot of vested interests Regards Angela”[3] [Emphasis mine] The Bank of England and the British Bankers Association not only knew about LIBOR manipulation but the BBA immediately informed other Central Banks but not the regulatory authority, the FSA. Perhaps further investigations of the LIBOR affair by British authorities will get us closer to the truth but I am not holding my breath. In the meantime, London bears watching. Any significant change to the “LIBOR regime” or its removal and replacement by something perhaps less easily finagled, as had been requested in 2008 by experts, will be determined in London, definitely with input from U.S. agencies as Mr. Geithner has stated in interviews. He also wants more U.S. banks represented on the panel. The ‘experts’ involved to fix LIBOR or create a better benchmark impossible to rig will need all the guidance they can get. Domine Dirige Nos.

A ‘boring’ Topic

The integrity of benchmark reference rates such as LIBOR is not a sexy topic. Like most of the other ‘boring’ matters concerning “financial innovations” and their abuse, it did not arouse much interest or curiosity even after evidence of manipulation started to surface. With a few notable exceptions, nobody seems to have looked or asked questions. Wonderful for those tempted to falsify the numbers. Eventually both, British[4] and U.S. regulators[5a] rose to action and a few weeks ago fined Barclays as the first bank of 16 under investigation a total amount of about US $455 million. The Bank of England and British lawmakers forced ‘brash American’ CEO Diamond and other executives to resign.

Culpable Barclays Bank, PLC, entered into an agreement with the U.S. Department of Justice (DOJ), revealing that “between 2005 and 2007, and then occasionally thereafter through 2009, certain Barclays traders requested that the Barclays LIBOR and EURIBOR submitters contribute rates that would benefit the financial positions held by those traders.”[5b] The Appendix A, Statement of Facts of the DOJ who called the transgressions “organized fraud,” is the most lucid summary of Barclays’ malfeasance, surprisingly devoid of incomprehensible legalese. The settlement documents signed by Barclays with the Commodity Futures Trading Commission (CFTC)[6] and the U.S. Department of Justice (DoJ) include employee emails and reveal three ways of LIBOR manipulation: “(1) changing the survey response for the benefit of Barclays’ derivatives trade positions, (2) changing the survey response to protect Barclays’ reputation, and (3) attempting to induce other banks to change their survey responses.” See the also LIBOR: Frequently Asked Questions, Congressional Research Service.[7]

After Barclays’ confessions and fines, media interest slowly awakened. Many, including legislators and regulators, seemed shocked that LIBOR had been manipulated. Their professed “shock” appears as genuine as Captain Louis Renault’s when he learns of the gambling going on in "Rick's Café Américain" in Casablanca. (Great movie!) Like gambling at Rick’s, LIBOR rate manipulation was an open secret. In 1991, inexperienced trader Douglas Keenan began working at Morgan Stanley in London whose head of Interest Rate Trading in those days was none other than Bob Diamond of Barclays fame. When Keenan lost some money on future contracts, he was sure he had been defrauded: the settlement LIBOR rate was different from what appeared on his live screens. He complained to the London International Financial Futures and Options Exchange (Liffe), now part of NYSE Euronext, but didn’t get a satisfactory answer. He sought advice from some of his more experienced colleagues. They laughed at his naiveté and told him banks “misreported the LIBOR rates in a way that would generally bring them profits or reduce their losses.”[8a] In a two-and-a-half minute Reuters Video he states that LIBOR rigging was common knowledge and widespread back in 1991.[8b] Keenan, now an independent mathematical scientist, contacted the House of Commons Treasury committee currently investigating the LIBOR fraud but was told his testimony was not wanted because it “contradicts the narrative.” Don’t be surprised if the final narrative out of London will start anno domini 2008 even though Barclays already admitted to the U.S. DoJ that numbers had been misstated between 2005 and 2009. In the U.K. Financial Times journalist Gillian Tett and others heard “strange tales” about LIBOR, TIBOR (Tokyo Interbank Offered Rate) and EURIBOR (EURO Interbank Offered Rate) more than five years ago. Whenever she and her curious colleagues tried to investigate, they “faced obfuscation” and were brushed off.[9] There was obviously great interest by all involved to keep the LIBOR affair quiet.

The Lone Ranger – The Wall Street Journal

The U.S. regulatory agencies seem to have been the driving force in the current investigations of LIBOR rigging. The official U.S. investigation began in 2010, almost three years after the FRBNY first became aware of problems. When on July 13, 2012, the New York Fed responded to congressional request for information,[10] they included records starting with the illuminating FRBNY Weekly Market Review 04/12/2008. The Federal Reserve short term Lending rates, especially Term Auction Facility (TAF) rates were reported as considerably higher than LIBOR. The FRBNY comments: “the fact that the TAF stopped out above LIBOR has also triggered a significant amount of questions over the accuracy of the BBA's LIBOR fixing rate. Over the past few weeks, the 1-month term dollar deposit rate and the 1-month LIBOR fixing have diverged by as much as 30 basis points. The divergence between the two rates is similar to that observed during prior periods of heightened market stress, most notably in August and early December 2007. Our contacts at LIBOR contributing banks have indicated a tendency to under-report actual borrowing costs when reporting to the BBA in order to limit the potential for speculation about the institutions' liquidity problems.”[11] [Emphasis mine] The New York Fed also notes that over the same period when LIBOR was around 2.7%, some banks paid as much as 10% for actual brokered overnight fed funds.

Misreporting LIBOR was considered as early as 1998 by Jeremy Berkowitz of the Federal Reserve Board (FRB), Washington, D.C. In a 25-page report, he analyzed the possible worst-case scenario of false reporting (accidental or deliberate) and how to minimize it by using “robust estimation,” a statistical tool that minimizes the effects of manipulation. It seems his scholarly and quite technical paper, was ignored by the rest of the Federal Reserve System.[12] But fancy statistical knowledge or a degree in high finance is not necessary to suspect the LIBOR rate may be misstated as the Wall Street Journal (WSJ) proved in the spring of 2008. The author, Carrick Mollenkamp, reported on April 16, 2008, of a November 2007 meeting of the BoE with U.K. banks where, according to minutes of the meeting, “several group members thought that Libor fixings had been lower than actual traded interbank rates through the period of stress.” He then looked at LIBOR contributing banks’ 3-months rates, courtesy of BBA. The rates of banks in reasonable health show sometimes higher rates than those in poor financial health. That makes no sense to anyone who has ever applied for a loan or mortgage. The higher the risk of not paying back the loan, the higher the interest rate charged.

Banks at higher risk have higher borrowing costs. So it should be with LIBOR. But this was not the case. For example, Westdeutsche Landesbank, aka WestLB, supplied the lowest rate of 2.71000%, the Royal Bank of Scotland 2.70500%, Barclays 2.7200%, and the healthiest of them all, Royal Bank of Canada gave a rate of 2.71750. Both WestLB of Germany and the Royal Bank of Scotland, U.K., collapsed and were partially or fully nationalized in their home countries. They obviously fudged their LIBOR numbers as Scott Peng, interest-rate strategist at Citigroup, Inc. suspected. He went ahead and calculated the rates these various banks ought to supply to LIBOR, given their risk profile. It led him to believe LIBOR rates should be higher by at least 0.3% as the WSJ reported.[13] That miniscule percentage is not peanuts if billions or trillions in financial instruments are involved or if you hold an adjustable rate mortgage, see LIBOR – part III.

In a superb piece of often cited investigative reporting, Carrick Mollenkamp and Mark Whitehouse followed up on the April 16 WSJ article with Study Casts Doubt on Key Rate on May 29, 2008. The authors point out that their analysis “doesn’t prove that banks are lying or manipulating Libor” and take pains to list a number of reasons for the unusual LIBOR movements. The reader, however, cannot help but conclude that LIBOR numbers were fudged when looking at the chart “Quick Shift.” From about April 4 to 16, the 3-month dollar LIBOR hovered around 2.7%. After the WSJ had questioned its veracity on April 16, LIBOR jumped within a couple of days to over 2.9%, a substantial increase and probably closer to where LIBOR should have been. All banksters on both side of the Atlantic must have been reading the WSJ. A crime was being committed but neither the U.K. nor the U.S. watchdogs barked.

In their simple, brilliant analysis to determine if LIBOR still reflects the actual cost of borrowing, the authors took the contributing banks’ submissions for three-months USD LIBOR between April 2007 and May 2008 and plotted them. Then they looked at credit default swaps (CDS) for each bank provided by Markit since these swaps reflect the market’s view of the risk that a given bank will renege on its debt. With this information the Journal constructed an alternative “borrowing rate” for each of the 16 banks and plotted them. Their methods were checked by a finance professor at the London Business School and a statistics professor at Columbia University. From about July 2007 on the graph shows that the LIBOR numbers, the costs of borrowing, were consistently lower than what the market judged them to be. LIBOR quotations no longer reflected the banks financial health.

The WSJ interactive graph shows six banks. Only the Royal Bank of Canada reported rates closest to the market-based estimate. From late January through April 16, 2008, Citigroup’s rates were about 0.87 percentage points lower than what the CDS market indicated, JPM about 0.43%, WestLB 0.70%.[14] I can highly recommend this gem of investigative journalism. If you don’t subscribe to the WSJ, just “Google” the title. Both WSJ articles were ignored by readers judging by nil comments for more than four years until the appearance of a recent lone comment for each article. In 2008 nobody seemed to have realized that rigging LIBOR most likely affected their own lives. I will get to how it affects us in part III.


Geithner’s LIBOR pains – Part I ( ) for Treasury Secretary Geithner’s testimony, how LIBOR is determined, who are the contributing banks and relevant documents and links.


[1] Donald MacKenzie on the Importance of Libor, What’s in a Number?

[2] J. Moulds, The Guardian, Bank of England deputy governor Paul Tucker fights Libor accusations - as it happened,

[3] Bank of England Documents: LIBOR recommendations by Mr. Geithner, correspondence between BoE and BBA,

[4] Financial Services Authority, Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR,

[5a] U.S. Dept. of Justice, Barclays Bank PLC Admits Misconduct Related to Submissions for the London Interbank Offered Rate and the Euro Interbank Offered Rate and Agrees to Pay $160 Million Penalty,

[5b] For details, see also well-written U.S. DOJ, APPENDIX A, STATEMENT OF FACTS [details how Barclays’ traders and submitters of LIBOR/EURIBOR numbers did it],

[6] UNITED STATES OF AMERICA, Before the COMMODITY FUTURES TRADING COMMISSION, In the Matter of: Barclays PLC, Bat'clays Bank PLC and Barclays Capital Inc., Respondents, CFTC Docket No. 12 - 25,

[7] Congressional Research Service, Edward V. Murphy, Specialist in Financial Economics, LIBOR: Frequently Asked Questions, July 16, 2012,
[8a] Douglas Keenan, My thwarted attempt to tell of Libor shenanigans, Financial Times, 27 July 2012,

[8b] Douglas Keenan interview, Reuters video,

[9] Gillian Tett, Financial times, Bank lending probe lights up dark financial corners, Feb. 9, 2012,

[10] New York Fed Responds to Congressional Request for Information on Barclays - LIBOR Matter, July 13, 2012,

[11] Federal Reserve Bank New York, April 11, 2008: MarketSOURCE Weekly Market Review,

[12] Jeremy Berkowitz, Federal Reserve Board, Dealer Polling in the Presence of Possibly Noisy Reporting, February 20, 1998,

see also, Professor J. Berkowitz, U. Houston, publications,

[13] Carrick Mollenkamp, The Wall Street Journal, Bankers Cast Doubt On Key Rate Amid Crisis, April 16, 2008,

[14] Carrick Mollenkamp and Mark Whitehouse, The Wall Street Journal, Study Casts Doubt on Key Rate, May 29, 2008,

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