Could gold be the next Libor scandal?
US regulator considering an inquiry into London’s gold and silver markets to check if prices are open to manipulation
The Guardian, Wednesday 13 March 2013 19.08 GMT
The fixing of the gold price in London dates back to September 1919. Photograph: Grant Smith/Alamy
London’s financial sector was last night bracing itself for another official investigation into alleged price-fixing following reports that a US regulator is considering launching an inquiry into the City’s gold and silver markets.
The Commodity Futures Trading Commission is discussing whether the daily setting of gold and silver prices in London is open to manipulation, according to the Wall Street Journal, which stated that the CFTC is examining whether prices are derived sufficiently transparently.
The system of setting gold prices in London is unusual and involves a twice-daily teleconference involving five banks – Barclays, Deutsche Bank, HSBC, Bank of Nova Scotia and Société Générale – while silver is set by the latter three. The price fixings are then used to determine prices worldwide.
The news of the potential investigation comes after analysis of a similarly unusual system – the process used to determine the London interbank offered rate, known as Libor – uncovered manipulation and triggered multi-billion dollar fines against a group of banks.
Barclays was hit with a £290m fine last year, which resulted in the departure of its chief executive Bob Diamond and chairman Marcus Agius. Royal Bank of Scotland is paying fines of £390m for its role in Libor-rigging.
The fixing of the gold price in London dates back to September 1919, when the process involved NM Rothschild & Sons, Mocatta & Goldsmid, Samuel Montagu & Co, Pixley & Abell and Sharps & Wilkins.
At the start of each gold price-fixing, the chairman announces an opening price to the other four members who relay this price to their customers. Based on orders received from them, the banks declare themselves as buyers or sellers at that price.
Provided there are both buyers and sellers at that price, members are then asked to state the number of bars they wish to trade.
Spokespeople for all five banks involved did not comment when contacted last night.
If at the opening price there are only buyers or only sellers, or if the numbers of bars to be bought or sold does not balance, the price is moved and the same procedure is followed until a balance is achieved. The silver fix dates back to 1897.
Statistics: Posted by yoda — Fri Mar 15, 2013 12:13 am
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Deutsche Bank Made Huge Profit on Libor Bets
Bank, on whose advisory board sits Chuck Hagel, is also being investigated for Iran sanctions violations
BY: Washington Free Beacon Staff
January 10, 2013 11:43 am
Deutsche Bank, on whose board sits President Barack Obama’s secretary of defense nominee Chuck Hagel, made major profits in 2008 on bets related to the London interbank offer rate (Libor).
Deutsche Bank made at least $654 million in 2008 from trades pegged to the Libor currently being investigated by regulators, the Wall Street Journal reported.
The German bank’s trading profits resulted from billions of euros in bets related to the London interbank offered rate, or Libor, and other global benchmark rates.
Regulators have been investigating allegations that more than a dozen banks, including Deutsche Bank, rigged Libor and other interest rates underpinning trillions of dollars in loans and other financial contracts. …
So far, an internal inquiry by Deutsche Bank aimed at uncovering evidence of Libor manipulation has found misconduct by just a few individuals, people close to the bank said. As part of its cooperation with investigators, Deutsche Bank still is checking all the trades for any suspicious signs.
Regulators have alleged a conspiracy by global banks to rig interest rates, with some traders brazenly boasting about their prowess at moving the influential rates up or down at their whims. Libor is determined daily using bank-submitted estimates of how much it would cost the banks to borrow in different currencies and over different time periods.
The Free Beacon reported in December that Hagel sits on the board of Deutsch Bank. This is not the first time the bank has been investigated for shady dealings.
The bank is also under investigation for allegedly violating a United States trade embargo on Iran’s oil and energy sector, which is believed to play a key role in Tehran’s nuclear enrichment program.
Statistics: Posted by yoda — Thu Jan 10, 2013 11:46 am
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Behind the Scenes in the Libor Interest Rate Scandal
There have been plenty of banking scandals, but none quite like this: Investigators and political leaders believe that the manipulation of the Libor benchmark interest rate was the result of organized fraud. Institutions that participated could face billions in fines and penalties. By SPIEGEL Staff
Eduard Pomeranz and Rolf Majcen are small fish in the shark tank of international high finance. Their hedge fund, FTC Capital, is headquartered in tranquil Vienna and manages only €150 million ($189 million) in assets. But now Pomeranz, the founder, and Majcen, the head of the legal department, have been able to strike fear in the hearts of the big fish.
"The Libor manipulation is presumably the biggest financial scandal ever," says Majcen, a man with slightly disheveled-looking hair and Viennese sarcasm. Yes, he says, it did shock him that something like this was even possible, namely that a group of international banks had been manipulating interest rates for years. But Majcen takes a matter-of-fact approach to it all. As a financial professional, he is only one of many who want to get back the money that they feel they’ve been cheated out of.
At the end of June, British and American regulators imposed a $500 million fine on Barclays, the major British bank, and forced its CEO Bob Diamond to resign. Since then, a war of sorts has erupted in the financial sector. Investigators are attacking presumed offenders, banks that are involved are denouncing others in the hope of mitigating their own penalties, and small investors like Majcen are inundating Libor banks with lawsuits.
Deutsche Bank and more than a dozen other financial giants have come under sharp criticism due to the alleged manipulation of the Libor ( London Interbank Offered Rate), a benchmark interest rate. Some are even referring to the banks that are instrumental in calculating that rate a cartel, the sort of vocabulary not normally associated with the financial industry.
Regulators are using terms like "organized fraud." European Justice Commissioner Viviane Reding has suggested that bankers ought to be called "banksters." But in the case of some agencies, especially in New York and London, the outcry is also convenient; it diverts attention away from their own failures. For years, regulators overlooked what was happening right in front of their eyes.
Now that the authorities have woken up, they are aggressively pursuing the offenders — and are reaching all the way up to the boardrooms. More than half a dozen government agencies, from Canada to Japan, are investigating the case.
German authorities are also involved. A dozen employees of Germany’s central bank, the Bundesbank, have paid several visits to Deutsche Bank in recent weeks. They work for BaFin, the German federal financial supervisory authority, which has ordered a special audit, and are poking around the bank’s headquarters in Frankfurt, traveling to London, where its money market traders are based, and flying to Tokyo. Even the bank’s two new co-CEOs, Anshu Jain and Jürgen Fitschen, are expected to sit down for a question and answer session with the auditors. This is particularly unpleasant for Jain, who, as head of the investment banking division during the period in question, was ultimately responsible for money market transactions.
Libor, Anchor of the Financial World
The Libor and Euribor (Euro Interbank Offered Rate) are used worldwide as the benchmark rates for financial transactions worth hundreds of trillions of euros. When a savings bank issues a loan to a business at a variable interest rate, the loan agreement is based on the Euribor. "In many cases, the Euribor is even the key guideline for the structuring of call money," says Falko Fecht, a professor at the Frankfurt School of Finance, referring to overnight and other such short-term loans. In Spain, in particular, tens of thousands of construction loans are based on the Euribor, while millions of mortgage loans in the United States are pegged to the Libor rate.
But the bankers in the cartel initially had their sights set on a completely different business. They wanted to influence the giant market for interest rate and foreign currency derivatives in their favor. The volume of outstanding transactions in this area amounted to €567 trillion at the end of 2011 alone. Changes of as little as 0.01 percentage points can translate into hundreds of millions in profit or loss for some banks. This makes the lax approach to the calculation of rates taken for years by banks and regulators alike seem all the more astonishing.
A total of no more than 18 banks, including Deutsche Bank, are involved in the calculation of the Libor. Every morning, they submit estimates of the costs at which they believe they could borrow money on the markets without collateral. Using the resulting data, financial services provider Thomson Reuters calculates averages — for 10 different currencies and 15 different borrowing periods.
A similar method is used to calculate the Euribor, except that there significantly more banks — 43 — involved in the process.
Nevertheless, it is hardly a rigorous calculation. The averages are based on rule-of-thumb estimates; the market supposedly reflected in the data sent to Thomson Reuters has been dead since the financial crisis. Only very few banks can borrow money today without furnishing collateral.
Furthermore, neither bank executives nor regulators have shown much interest in how the important benchmark rate is determined. Inputting the data was often left to ordinary money market traders, who had serious conflicts of interest and acquired a dangerous amount of influence on the financial world. "The Libor interest rate was practically an invitation to manipulate," says BaFin head Elke König.
The Cartel Emerges
In 2005, a young trader with Moroccan roots came to Barclays: Philippe Moryoussef, who is now 44. For him, it was only one station of many: Société Générale, Barclays, Royal Bank of Scotland, Morgan Stanley and, finally, Nomura. The Japanese had let him go when it became clear what role Moryoussef allegedly played in the interest-rate cartel.
In the London financial district, Moryoussef was seen as cool and unassuming. He liked diving, read books and didn’t put on airs in public, even when he moved into a £2.5-million ($3.9 million) apartment in London’s St. John’s Wood neighborhood with his wife and two children.
Moryoussef traded in interest rate derivatives during his time at Barclays. He and his fellow traders knew exactly how much money they stood to lose or gain if the Libor or Euribor changed by only a fraction of a percentage point in one direction or the other.
And they apparently did everything they could to eliminate happenstance. Moryoussef communicated by phone or email with colleagues inside and outside the bank almost daily to steer interest rates in the right direction. To do so, they sent inquiries to the people who were responsible for inputting the Libor rates: the money market traders.
In the glitzy world of investment banking, money market traders were at the bottom of the pecking order before the financial crisis. They were not involved in major deals, and they could only dream of the kinds of bonuses stock and bond traders received. "They were always at the bottom of the food chain," says a former investment banker.
It was a conspiratorial group of underdogs who worked for various banks and met at least once a month for a beer or a mojito in New York, London or Frankfurt. By the middle of the last decade, when there seemed to be a surplus of money at the banks, they all had the same problem: They were derided or, worse yet, ignored by their colleagues in the trading rooms of major banks.
But what if it were possible to know where interest rates were headed at the end of the day, or even in the next hour? What if a few traders could manipulate the ups and downs of interest rates?
By 2005 at the latest, the traders would seem to have begun realizing just how much power they had were they able to collaborate within their small group. There was no need for formal contracts between large institutions, merely agreements among friends. A pointer here, a few traders meeting for lunch there, and soon the group had formed a global cartel that, according to investigators, reached from Japan to Europe to Canada.
"Come on over; I’ll open a bottle of Bollinger," a trader, inebriated with his success, wrote to a colleague after the Libor rate had been set. Adair Turner of the British regulatory agency quotes the email as evidence of "a culture of cynical greed in the trading rooms."
The Organized Fraud
"If the rate remains unchanged, I’m a dead man," a trader emailed to a colleague who was responsible for Libor in October 2006. The traders sent at least 173 inquiries of this nature between 2005 and May 2009 for the dollar Libor alone. They were often successful.
Moryoussef, listed in the files of Britain’s Financial Services Authority (FSA) as "Trader E," specialized in the Euribor. He reportedly bet €30 billion on certain movements of the interest rate, a normal dimension in the fast-paced money market. "The trick is that you can’t do it alone," he bragged to outside colleagues at HSBC, Société Générale and Deutsche Bank, who allegedly cooperated with him.
While the traders were initially out to increase their bonuses, the manipulation took on a different dimension during the crisis. When the first banks began to wobble in 2007, it became more difficult for many financial companies to borrow money — a problem that would normally be reflected in higher Libor rates.
Now even top managers at Barclays, alarmed by media reports, were instructing the Libor men to input lower rates. In October 2008, the manipulation became a question of survival for Barclays. On Oct. 29, a concerned Paul Tucker, now the deputy governor of the Bank of England, contacted Barclays CEO Diamond. Tucker wanted to know why the bank was consistently inputting such high interest rates into the daily Libor report.
Diamond told a parliamentary committee that Tucker had suggested to report lower interest rates for the Libor, which Tucker staunchly denies. Diamond, for his part, prepared a transcript of the telephone conversation he had had with Tucker on that day, in which he had mentioned political pressure. After that, his chief operating officer spoke with the money market traders. The underdogs were suddenly being heard on the executive board, and had become the bank’s potential saviors.
Barclays wasn’t the only bank that was having trouble gaining access to money in the fall of 2008. UBS, Citigroup and the Royal Bank of Scotland, now prime suspects in addition to Barclays, had to be bailed out by their respective governments. Germany’s WestLB, which was involved in the Libor calculation at the time, was also seen as a problem case, although this wasn’t reflected in the Libor rates it was reporting.
As early as the fall of 2011, Deutsche Bank’s chief risk officer at the time, Hugo Bänziger, ordered an internal audit. Millions of emails had to be reviewed and chat minutes read. Bänziger hired an outside auditing firm, and soon there were 50 people on the team responsible for the scandal. But it was a deeply frustrating task for the auditors; they didn’t even know where to begin.
Only when British investigators released the names of two suspicious traders was the audit team able to report success to then CEO Josef Ackermann. Seemingly sensing what was in store for his bank, he inquired about the progress of the audit on a weekly basis. Two traders were fired.
Since the departures of Ackermann, Bänziger and former Supervisory Board Chairman Clemens Börsig, Börsig’s successor Paul Achleitner has managed the bank’s handling of the Libor scandal. He is reportedly firmly convinced that the bank never tried to push down the Libor to improve its own position. Financing problems? Not at Deutsche Bank, says Achleitner. He also notes that there are no indications that executive board members, or even Anshu Jain, were directly involved in the scandal.
But is it possible that only two wayward traders took part in the cartel? Why were no supervisors and no compliance officers aware of their activities? Deutsche Bank prides itself on being a world leader in the trade in foreign currencies and interest rates. It is part of all panels involved in determining the Libor. And yet Deutsche Bank merely sees itself as a bit player in the Libor-fixing scandal.
But why then was Alan Cloete, thought to have been responsible for the money market business and other areas during the wild Libor years, unaware of the manipulation? And why did Jain promote the stocky South African to the expanded executive board in March, while the investigations and internal audits in the Libor matter were already underway? There are those associated with the bank who think this is odd, while others see it as proof that Cloete is blameless in the Libor case.
The Failure of the Regulators
On April 11, 2008, a member of the Barclays money market team called Fabiola Ravazzolo, an employee of the Federal Reserve Bank of New York.
Barclays employee: "LIBORs do not reflect where the market is trading, which is, you know, the same as a lot of other people have said."
Ravazzolo: "Mm hmm."
A few moments later, the Barclays man, according to the transcript of the conversation released by the bank, said: "We’re not posting, um, an honest Libor."
Barclays-Mann: "We are doing it, because, um, if we didn’t do it it draws, um, unwanted attention on ourselves."
There was no sense of outrage, nor did Ravazzolo question the Barclays employee about the details. A similar conversation transpired with another Fed employee a few months later.
These are transcripts of failure. Barclays employees also contacted British regulators 13 times to report possible misconduct among the competition in determining the Libor, FSA chief Adair Turner admitted in a hearing before the British investigative committee. No one sounded the alarm.
In the United States, the issue ultimately did make it further up the ladder, reaching the desk of Timothy Geithner, who was chairman of the New York Fed at the time before becoming US treasury secretary. At the end of May, he sent an email on the subject of the Libor to the governor of the Bank of England, writing: "We would welcome a chance to discuss these and would be grateful if you would give us some sense of what changes are possible." Attached to the message were two pages of "Recommendations for Enhancing the Credibility of LIBOR". It was anything but a warning about manipulations.
At first, there was no reaction from the other side of the Atlantic, and Geithner’s office had to send a reminder email on June 1. Two days later, Bank of England Governor Mervyn King finally responded, writing that the recommendations seemed "sensible" and that he would be happy to discuss the matter further with Geithner.
But nothing further happened in the ensuing months. The financial crisis was coming to a head with the bankruptcy of investment bank Lehman Brothers. The central bankers had other worries. This remains the regulators’ line of defense today. If the world hadn’t happened to be on the edge of an abyss, they say, the Libor scandal would certainly not have slipped through their fingers as easily.
Meanwhile, the US Commodities Futures Trading Commission (CFTC) had been investigating the issue since 2008, and its efforts eventually led to a worldwide investigation.
The Episode Is Blown Wide Open
"Mechanisms are now taking effect that I only knew of from mafia films," a shaken financial regulator said recently. Since investigations have gone into high gear in New York, London, Brussels and elsewhere, suspected bank executives have been coming clean.
They are under great pressure. Last year, the European Commission filed several antitrust suits against various banks. Antitrust suits are considered to be the sharpest weapons in business law because they allow Brussels to impose stiff penalties on cartel participants.
"In our investigations, we concentrate on suspicious cartel agreements that include derivatives. This includes possible secret agreements about the determination of these lending rates," says European Competition Commissioner Joaquín Almunia. In other words, the investigators are interested in more than the manipulation of global interest rates to benefit specific parties. It’s also possible that the enormous market for derivatives was manipulated.
"Derivatives traders are also believed to have agreed upon the difference between the buy and sell prices (spreads) of derivatives, thereby selling these financial instruments to customers under conditions that were not customary in the market," says the Swiss Competition Commission, which is also investigating possible cartels.
It is difficult to find clear evidence, such as a written cartel agreement. But in Brussels alone, more than 40 banks have contacted authorities to report what they know about years of manipulation. The first star prosecution witness to reveal new information about a cartel and provides evidence stands to see his own fine eliminated entirely. The second can expect Brussels to reduce his fine by up to 50 percent and the third by up to 30 percent.
The European Commission can demand up to 10 percent of a year’s profits from the banks. "There could be new record-breaking fines," says an employee at the Directorate-General for Competition in Brussels. Individual banks could expect to be slapped with fines of more than €1 billion by the EU.
In the United States, the Justice Department has joined financial regulators in conducting the investigations. This means that the scandal could also have criminal and not just civil consequences for a number of banks, say sources in Washington. Charges will likely be filed against at least one bank this year. US Congress has also announced plans to launch its own investigation.
It wasn’t until the fall of 2011 that German financial regulators at BaFin headquarters in Bonn learned of the dimensions of the scandal from their counterparts in the United States and Great Britain. They had been largely unaware of the problem until then. Raimund Röseler, the chief executive for banking supervisor at BaFin, then prepared a special investigation, which has been underway since May.
What the Banks Could Now Face
German banks must have pricked up their ears when BaFin President Elke König recently spoke about the Libor scandal. "Basically, banks must establish suitable reserves for possible losses," König concluded.
Investors, like Vienna hedge fund FTC Capital, have made it clear that they do not intend to let up. They feel obligated to their customers to file claims for damages, explains FTC executive Majcen. Friedrich von Metzler, whose bank feels harmed by the rate manipulation through a fund subsidiary, has filed a lawsuit for the same reason.
There are already 20 lawsuits in the United States, some of which have been combined into class action suits. The plaintiffs range from the City of Baltimore to police and firefighter’s pension funds, the City of Dania Beach, Florida, and Russian oligarch Vladimir Gusinsky.
They feel encouraged by the actions of regulators. "Both the American CFTC and the FSA have done excellent investigative work," says Majcen. Bank analysts expect that other institutions could face fines similar to the one imposed on Barclays. In fact, it ought to be in the banks’ best interest to quickly settle their cases. "But they’re afraid, because since Barclays, they know that it isn’t just about money, but also about making heads roll," says a major shareholder of Deutsche Bank.
German attorneys are also lining up to represent potential clients. "A few institutional investors have already contacted us," says Marc Schiefer of the law firm TILP in the southern German city of Tübingen.
Years could go by before damage suits are ruled on. FTC executive Majcen expects that it will take until at least the spring of 2013 for the courts to decide whether to hear the cases, while the evidentiary hearings and trials could take another three to five years. Nevertheless, investment bank Morgan Stanley has already made its projections, estimating the total cost to the banks, including fines and damage payments, at $22 billion, of which $1.5 billion would apply to Deutsche Bank.
Possible Libor-related liabilities would cause serious problems at WestLB, or its successor company Portigon. The once-proud state-owned bank is in the process of being liquidated, at a cost of billions to its former owners, the western German state of North Rhine-Westphalia and savings banks. The Libor scandal could further increase the burden on taxpayers.
BaFin has launched a major offensive to determine whether WestLB and possibly other German banks were involved in the rate-fixing scandal. Letters were sent to all banks that assist in the calculation of the Euribor, giving them until last Thursday to explain their internal processes for calculating the euro interest rate and, most of all, their monitoring mechanisms. If responses suggest possible lapses, these banks could also see special auditors knocking on their doors.
Fund companies also received mail from Bonn. They were asked to determine which of their products are affected and, if possible, to report their possible losses.
Things will get especially uncomfortable for Deutsche Bank, because BaFin intends to double its regulatory capacities for the bank in the near future. Instead of two departments, there will be three or four devoted to Deutsche Bank. The regulator will reshuffle its internal organization to free up the necessary employees.
BaFin has also just prepared a position paper on a subject that is especially sensitive for Jain. The agency is now intensively addressing the question of how, in investment banking, the dangerous practice of proprietary trading could be isolated from the rest of the business through holding structures.
The regulators speculate that relevant draft legislation proposed by Britain’s Vickers Commission could also apply to German banks. Nikolaus von Bomhard, CEO of insurance giant Munich Re and a member of the supervisory board of Commerzbank, Germany’s second-largest bank, recently made the case for a breakup of major banks. Achleitner, a member of the board of Allianz under recently, was reportedly deeply upset about former colleagues in the industry.
The call for stricter regulation is also getting louder in politics once again. Sigmar Gabriel, chairman of the center-left Social Democratic Party (SPD), has discovered bank-bashing as an effective campaign tool, and has declared the next election, in the fall of 2013, as a "decision on the taming of the banking and financial sector."
Finance Minister Wolfgang Schäuble, a member of the center-right Christian Democratic Union (CDU), accused Gabriel, a potential SPD candidate for the chancellorship, of "cheap populism." But the remark sounded more duty-bound than genuine, especially given the fact that there is also considerable outrage over the Libor scandal in Berlin.
"This is a real zinger," says an insider. In the past, bank manager lapses resulted from their stupidity for having bought securities without understanding them. "Now that was bad enough. But manipulating a market rate is criminal." A portion of the industry, adds the insider, apparently doesn’t realize that the writing is on the wall.
The parties involved, including Deutsche Bank and its new co-CEO Jain, cannot expect leniency when charges are investigated. "We can’t make any allowances for high-profile names," say officials in the capital.
BY SVEN BÖLL, MARTIN HESSE, CHRISTOPH PAULY, THOMAS SCHULZ and ANNE SEITH
Translated from the German by Christopher Sultan
Statistics: Posted by yoda — Wed Aug 01, 2012 8:44 am
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LIBOR, Lies and Derivatives
MONDAY, JULY 30, 2012
Three weeks, ago, I wrote LIBOR was a criminal conspiracy from the start. An avalanche of articles have been written on LIBOR since, and I think an update is in order, which also gives me a chance to delve a little further into the bold statement in that title.
It’s not that I’m a big fan of using terms like conspiracy, not at all, but then again, neither am I a fan of constantly being lied to.
The average Joe and Jane and Jack and Jill in the street should be able to rely on the fact that those who they vote in office represent them and their interests; it’s the very definition of the essence of our democratic systems. What they get instead, and increasingly so, are lawmakers and regulators who collude with private industries, which due to their size have grabbed an enormously bloated hold on political power. In the US, the UK and EU the actual say a voter gets to exercise from the ballot box has been reduced to something that fast approaches the freezing point.
The story of LIBOR is an excellent example of the inner workings of this process, and of the consequences that follow. Of course, when I label it criminal, I make a moral judgment, knowing full well at the same time that it’s the lawmakers themselves who in the end define what’s legal or not, and what’s criminal or not.
There is no segment of private industry that has grabbed more power than the banking industry. Indeed, it would be hard to find any lawmaker or regulator left at all in the western world willing to stand up to it in more than fleeting soundbites. We will see this exemplified in the upcoming procedures in the LIBOR rigging scandal.
Banks will offer up individual traders as lambs for the sacrificial chopping block, and lawmakers will declare that justice has been done. The traders can protest as much as they will that they were not operating in a vacuum, and that their superiors were very much aware of their machinations, if not outright demanding them, but it will make no difference. Bob Diamond was thrown to the wolves so Mervyn King could stay where he is. King himself made sure of it.
I don’t think that back in 1986, when LIBOR was initiated by the British Bankers Association in light of the advent of new financial instruments such as interest rate swaps, everything that has happened between then and now, 26 years later, was foreseen and consciously instigated. I do believe, however, that the conditions were consciously set to allow for it to happen. It all just got a lot bigger than those who were in charge back then, politicians, bankers and regulators, could ever have dreamed.
Still, the underlying idea for LIBOR was always: "by the bankers, for the bankers". And if anyone involved in setting up LIBOR back in the day now wishes to claim that they had no idea that allowing banks to make up the rates which they borrowed at out of thin air, might have led to manipulation, that would insult everyone’s intelligence including yours and mine. The problem is that in today’s climate, this doesn’t keep them from making precisely such claims. And that is very much part of a trend. It has increasingly become acceptable for bankers and politicians alike to deny anything flat out and see what happens, knowing their friends have their backs.
I don’t know that US Finance Secretary Timothy Geithner said it in exactly so many words, but he did at least strongly imply that he didn’t know about LIBOR manipulation until the spring of 2008. And then proceeded – along with the likes of Hank Paulson and Ben Bernanke – to base the rates for the bailout programs such as TARP, six months or so later, on that same manipulated rate, saving the banks tens of billions of dollars.
Bank of England Governor Mervyn King did him one better: he stated he didn’t know anything about LIBOR manipulation until 2 weeks prior to his Parliamentary hearing on July 17, despite receiving correspondence from Geithner telling him about it, over 4 years ago. Geithner declared he had been very clear, and even went to the unusual step of putting his warnings to King in writing. King claims he never saw any warning sign.
Let’s put it this way: If there is even a whiff of truth to King’s statements, he’s so spectacularly unfit for his job (or at least for what his job should be), it’s not funny. Still, he’s been in the job since 2003.
Some – pretty nauseating – quotes by King from that Parliamentary hearing: "No-one saw it because the game wasn’t fixed", and "There were concerns about the accuracy of LIBOR during the financial crisis but that is not the same as proof that the figures had been manipulated for private gain," [..] "That is my definition of fraud.". King then accused bankers involved in LIBOR rigging of "fraud motivated by personal greed". Mirror, mirror on the wall…
By the way, in November 2008 King described LIBOR to the UK Parliament like this: "It is in many ways the rate at which banks do not lend to each other, … it is not a rate at which anyone is actually borrowing."
Let’s be bluntly honest here, why don’t we: both Geithner and King are simply lying. And even if we can’t prove they are lying, we can certainly state that their words lack all plausibility. That is because LIBOR is arguably the most important number in the financial industry of the past two decades, and people who reach positions such as the ones Geithner and King hold, MUST have known for a long time what was going on with LIBOR.
Along the same lines that you don’t win a Nobel prize in physics if you don’t know that E=MC squared, you don’t get the world’s top jobs in overseeing banking and finance if you don’t know what and who is involved in LIBOR. If only because it would make you a potential threat to those profiting from it.
The reason LIBOR was used as the foundation for TARP and other bailouts despite the fact that in the fall of 2008 everyone in the field knew it was rigged (well, except for Mervyn King) was not because there were no – potentially more reliable – alternatives that could have been used. No, it was the very fact that LIBOR was the rate that could most easily be manipulated. And was. Had been for years. The proof is there for all to see. Emails and letters are there to show this, no matter what denials are issued.
Meanwhile the timeline for who knew, or should have known, what about LIBOR rigging keeps being pushed back.
Whereas Mervyn King, according to his own words, was as innocent as he was ignorant until early July 2012, and Tim Geithner found out in early 2008 (can we hear them both under oath next time, please?!), and other voices mentioned 2005, former Morgan Stanley trader Douglas Keenan wrote in the Financial TImes last week (My thwarted attempt to tell of LIBOR shenanigans) that when he came to the bank in 1991, his colleagues, who had been there longer, found him humorously naive for not knowing that LIBOR was actively being rigged.
That takes us smoothly back a good part of the way to 1986, LIBOR’s year of birth. If and when in 1991 it had been manipulated for long enough to have Keenan’s colleagues snicker at his ignorance, it seems safe to say that it has been rigged pretty much ever since its inception.
And how could it not have been? LIBOR requires no real data, no real rates at which banks lend and borrow. It merely asks banks to state every working day at 11.00 am GMT at what rate they think they can borrow. Ergo: anything goes. This was done on purpose. LIBOR was built to be rigged. And here’s what is was built for:
1986 was the time when the derivatives industry was starting to take off for real. An interest rate was needed to "guide" them. But not one that would be neutral or impartial, not if the bankers had any say in the matter. They had all the say they wanted and needed. Still, as I said, I don’t think it was a conspiracy in the sense that in 1986 anybody knew exactly how big it was all going to get (not that it matters; it’s about intent).
Derivatives "languished" for a while around the 1x global GDP level. Then they came into their own and rose to ten times that or more. The industry began to clue in on the virtually limitless possibilities.
Interestingly, Douglas Keenan writes that in his time at Morgan Stanley, the head of interest rate trading was nobody else than Bob Diamond, who 20-odd years later was forced to leave as CEO of Barclays, because of the LIBOR scandal, by Mervyn King, who claims he did not know, until mere days before that, what for all intents and purposes he should have known for a long long time. The interest rate trade gave birth to some of the earliest new financial instruments that led to the inception of LIBOR. By value, the vast majority of derivatives today consists of interest rate swaps.
The first half of the 1990s brought us Credit Default Swaps. They are habitually – and flatteringly – presented as instruments with which to hedge investments, an innocuous and benign form of insurance. Still, even if they once were invented and intended that way (which I think is highly doubtful), that’s not what CDS are used for these days. They have instead become instruments to hide (gambling) losses and allow the investor/gambler to circumvent reserve requirements.
You invest an $X amount of capital, leverage it Y times, buy a default swap on what you invested in, and do it all over again. Rinse and repeat. You don’t need to keep anything in reserve, since you have bought insurance at every step of the way. Given that the notional value of the derivatives market is somewhere between $500 trillion and $1 quadrillion, we can all get an idea of the leverage involved.
The entire mortgage investment based universe, CDOs, MBS, was/is based on LIBOR as well. Banks could go nuts, and do so all the way to the bank; not only could they insure themselves for a pittance against failure on highly leveraged wagers, through LIBOR they even controlled how much the insurance would cost. AIG stands out as the biggest counterparty; it insured anything under the sun.
From AIGs point of view, it didn’t matter what it insured, or what the rates were: CDS were never supposed to be triggered. They were – and are – merely a way to hide losses in plain sight. The AAA ratings that Moody’s and S&P gave them made it all even better: interest rates could be kept that much lower. All for the sake of the next, and preferably larger, wager. We know how this ended for AIG. It was given our money, so it could keep on hiding losses.
There are reports on plans to change LIBOR into a better, reality-based, standard. But these plans are once again being drawn up by the same people who have for years at best maintained a see no evil hear no evil attitude. If we want a real turnaround, if we want the lies to stop, the last thing we should do is to allow the same old same old crowd of politicians, regulators and bankers, to even come within a mile of negotiations for a new standard. The problem there is of course that there’s no one else left. The rot has spread to all corners of the industry that count. Innocence exists in name only.
The "resolution" of the LIBOR scandal (which will probably never be completed) will show us once again that we have a choice to make between either saving the banks or saving our economies and societies. We can’t do both. But in all honesty, I doubt that the prospect of such a choice is real. It looks to me like the choice has long since been made by a succession of unrepresentative representatives we elected with our empty votes, and who have left us with a runaway crossover between Frankenstein and the Sorcerer’s Apprentice. I wasn’t kidding when I said the other day that if you want your vote to count, you’ll have to get out into the streets to do so.
The LIBOR affair is one in a series of things laid bare by the ongoing financial crisis that will inevitably, at one point or another, force us to confront the moral bankruptcy that has come to control our societies.
Statistics: Posted by yoda — Mon Jul 30, 2012 10:52 am
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Libor = Lie-More
One-on-One with Paul Craig Roberts #2
18 July 2012 73 Comments
By Greg Hunter’s USAWatchdog.com
Former Assistant Treasury Secretary Paul Craig Roberts says, “The last thing the banks want is a rise in interest rates that would drive down the values of their holdings and reveal large losses masked by rigged interest rates.” The Libor rate rigging scandal was all about keeping the financial system and the big banks from failing. Forget prosecuting the perpetrators because Roberts says, “The minute those interest rates go up, the loss to people will just dwarf the interest rate loss.” Fraud is now part of the system that keeps it from crashing. Roberts has a PhD and was responsible for economic policy at the Treasury. He says, “We are probably headed for a crash anyway because I don’t think they can maintain this forever.” Join Greg Hunter as he goes One-on-One with Paul Craig Roberts
http://usawatchdog.com/one-on-one-with- … roberts-2/
Statistics: Posted by DIGGER DAN — Sun Jul 22, 2012 4:42 am
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Jim Rickards: Tim Geithner “Aided and Abetted” LIBOR Crimes
The economy is the main event but the LIBOR scandal will be on the under-card when Fed Chairman Ben Bernanke testifies before Congress again today.
At issue is what the Fed, and other bank regulators, knew about manipulation of the key lending rate and whether they condoned banks giving low-ball estimates of LIBOR in order to make themselves look healthier during the crisis of 2008.
Bernanke is likely to face some inquires about this issue, but the U.S. regulator most questions are being asked about is Treasury Secretary Tim Geithner, who is set to testify about the matter before the House Financial Services committee next week.
In 2008, while President of the NY Fed, Geithner sent a memo to British regulators to raise concerns about potential manipulation of LIBOR, as has been widely reported and confirmed Friday by the NY Fed.
This 4:32 video was posted on "The Daily Ticker" website yesterday morning…and was picked up by finance.yahoo.com Internet site yesterday
Statistics: Posted by DIGGER DAN — Wed Jul 18, 2012 9:08 am
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Libor: They all knew – and no one acted
Regulator’s claim it knew nothing thrown into doubt as documents show authorities were told of rate-rigging in 2008
BEN CHU SATURDAY 14 JULY 2012
Regulators on both sides of the Atlantic failed to act on clear warnings that the Libor interest rate was being falsely reported by banks during the financial crisis, it emerged last night.
Click HERE to view ‘The missed warnings how us authorities demanded changes… and were ignored’ graphic
A cache of documents released yesterday by the New York Federal Reserve showed that US officials had evidence from April 2008 that Barclays was knowingly posting false reports about the rate at which it could borrow in order to assuage market concerns about its solvency.
An unnamed Barclays employee told a New York Fed analyst, Fabiola Ravazzolo, on 11 April 2008: "So we know that we’re not posting, um, an honest Libor." He said Barclays started under-reporting Libor because graphs showing the relatively high rates at which the bank had to borrow attracted "unwanted attention" and the "share price went down".
The verbatim note of the call released by the Fed represents the starkest evidence yet that Libor-fiddling was discussed in high regulatory circles years before Barclays’ recent £290m fine.
The New York Fed said that, immediately after the call, Ms Ravazzolo informed her superiors of the information, who then passed on her concerns to Tim Geithner, who was head of the New York Fed at the time. Mr Geithner investigated and drew up a six-point proposal for ensuring the integrity of Libor which he presented to the British Bankers Association, which is responsible for producing the Libor rate daily.
Mr Geithner, who is now US Treasury Secretary, also forwarded the six-point plan to the Governor of the Bank of England, Sir Mervyn King. The Bank pointed out last night that there was no evidence in the Geithner letter of banks actually making false submissions – although then note did allude to "incentives to misreport".
It was unclear last night whether Mr Geithner informed Sir Mervyn about the testimony of the Barclays employee who said that the bank was being dishonest in its submissions.
If it turned out that he did, that would be highly damaging for the Bank since it has always claimed that it never saw or heard any evidence that private banks were deliberately making false reports about their borrowing costs. Sir Mervyn is due to be questioned by the House of Commons Treasury Select Committee next Tuesday, where MPs are likely to put this question to the Governor.
The Bank’s Deputy Governor, Paul Tucker, went before the Treasury committee last week to answer allegations that he had put pressure on Barclays to misreport its borrowing rates in 2008 while attempting to promote financial stability. Mr Tucker denied that he had done so and said he only found out that Barclays had been deliberately submitting dishonest Libor submissions recently.
The New York Fed released its cache of documents in response to a request from the chairman of Congress’s Committee on Financial Services on Oversight and Investigation, Randy Neugebauer, who has been investigating how much US regulators knew about the rate-fixing scandal, in which 11 other banks around the world have been implicated.
A separate email released by the Bank of England yesterday shows that Mr Tucker forwarded the Geithner email to Angela Knight, the former chief executive of the British Bankers Association. She responded saying that "changes had been made to incorporate the views of the Fed".
While the BBA is understood to have acted on two of Mr Geithner’s proposals, the other four were not adopted.
Before hearing from Sir Mervyn on Tuesday, the Treasury Select Committee is set to take evidence on Monday afternoon from Jerry del Missier, the former chief operating officer at Barclays, who gave the green light for traders to submit false Libor submissions during the crisis. He will be asked about whether he thought the order to do so had come down from the Bank of England.
Last month Barclays was fined £290m for rigging Libor between 2005 and 2008. The regulators found that Barclays traders had initially submitted false reports to make profits for its traders, but subsequently to allay concerns about the bank’s health. Barclays’ chief executive Bob Diamond resigned on 3 July. The Libor rate is used to fix the cost of borrowing on mortgages, loans and derivatives worth more than $450 trillion (£288 trillion) globally.
The missed warnings: ‘So we know that we’re not posting, um an honest Libor
One document released yesterday by the Fed detailed a conversation between staffer Fabiola Ravazzolo and an unnamed Barclays employee in April 2008, including the following edited extract:
Fabiola Ravazzolo: And, and why do you think that there is this, this discrepancy? Is it because banks maybe they are not reporting what they should or is it um…
Barclays employee: Well, let’s, let’s put it like this and I’m gonna be really frank and honest with you.
FR: No that’s why I am asking you [laughter] you know, yeah [inaudible] [laughter]
BE: You know, you know we, we went through a period where we were putting in where we really thought we would be able to borrow cash in the interbank market and it was above where everyone else was publishing rates.
FR: Mm hmm.
BE: And the next thing we knew, there was um, an article in the Financial Times, charting our LIBOR contributions… and inferring that this meant that we had a problem… and um, our share price went down… So it’s never supposed to be the prerogative of a, a money market dealer to affect their company share value.
BE: And so we just fit in with the rest of the crowd, if you like… So, we know that we’re not posting um, an honest LIBOR. And yet and yet we are doing it, because, um, if we didn’t do it it draws, um, unwanted attention on ourselves.
FR: Okay, I got you then.
BE: And at a time when the market is so um, gossipy… it was not a useful thing for us as an organization.
Statistics: Posted by yoda — Sat Jul 14, 2012 10:14 am
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The Big Losers in the Libor Rate Manipulation
By Washingtons Blog – July 5th, 2012, 1:30AM
Local Governments Which Entered Into Interest Rate Swaps Got Scalped
We know that the big banks conspired to manipulate Libor rates, with the approval of government authorities.
We know that the Libor manipulation effected the world’s largest market – interest rate derivatives.
But who are the biggest victims?
Sometimes the big banks manipulated the Libor rates up, and sometimes down. Different groups of people got hurt depending which way the rates were gamed.
Bloomberg’s Darrell Preston explained last year how cities and other local governments got scalped when rates were manipulated downward:
In the U.S., municipal borrowers used swaps to guard against the risk of higher interest costs on variable-rate debt by exchanging payments with another entity and tying how much they pay to an underlying value such as an index. The agreements can backfire if rates move in unexpected directions, resulting in issuers making larger payments.The derivatives were often designed to offset the risks of increases in the short-term rates tied to auction-rate securities, fixing borrowers’ costs by trading their debt- service payments with another party. Instead, rates dropped.
The yield on two-year Treasury notes fell from about 5.1 percent in June 2007 to a record 0.14 percent on Sept. 20. On Oct. 6, the U.S. Treasury sold $10 billion of five-day cash- management bills at 0 percent.
Ellen Brown adds:
For more than a decade, banks and insurance companies convinced local governments, hospitals, universities and other non-profits that interest rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels. This was not a flood, earthquake, or other insurable risk due to environmental unknowns or “acts of God.” It was a deliberate, manipulated move by the Fed, acting to save the banks from their own folly in precipitating the credit crisis of 2008. The banks got in trouble, and the Federal Reserve and federal government rushed in to bail them out, rewarding them for their misdeeds at the expense of the taxpayers. [The same thing happened in England.]
How the swaps were supposed to work was explained by Michael McDonald in a November 2010 Bloomberg article titled “Wall Street Collects $4 Billion From Taxpayers as Swaps Backfire”:
In an interest-rate swap, two parties exchange payments on an agreed-upon amount of principal. Most of the swaps Wall Street sold in the municipal market required borrowers to issue long-term securities with interest rates that changed every week or month. The borrowers would then exchange payments, leaving them paying a fixed-rate to a bank or insurance company and receiving a variable rate in return. Sometimes borrowers got lump sums for entering agreements.
Banks and borrowers were supposed to be paying equal rates: the fat years would balance out the lean. But the Fed artificially manipulated the rates to the save the banks. After the credit crisis broke out, borrowers had to continue selling adjustable-rate securities at auction under the deals. Auction interest rates soared when bond insurers’ ratings were downgraded because of subprime mortgage losses; but the periodic payments that banks made to borrowers as part of the swaps plunged, because they were linked to benchmarks such as Federal Reserve lending rates, which were slashed to almost zero.
In a February 2010 article titled “How Big Banks’ Interest-Rate Schemes Bankrupt States,” Mike Elk compared the swaps to payday loans. They were bad deals, but municipal council members had no other way of getting the money. He quoted economist Susan Ozawa of the New School:
The markets were pricing in serious falls in the prime interest rate. . . . So it would have been clear that this was not going to be a good deal over the life of the contracts. So the states and municipalities were entering into these long maturity swaps out of necessity. They were desperate, if not naive, and couldn’t look to the Federal Government or Congress and had to turn themselves over to the banks.
As almost all reasoned economists had predicted in the wake of a deepening recession, the federal government aggressively drove down interest rates to save the big banks. This created opportunity for banks – whose variable payments on the derivative deals were tied to interest rates set largely by the Federal Reserve and Government – to profit excessively at the expense of state and local governments. While banks are still collecting fixed rates of from 4 percent to 6 percent, they are now regularly paying state and local governments as little as a tenth of one percent on the outstanding bonds – with no end to the low rates in sight.
. . . [W]ith the fed lowering interest rates, which was anticipated, now states and local governments are paying about 50 times what the banks are paying. Talk about a windfall profit the banks are making off of the suffering of local economies.
To make matters worse, these state and local governments have no way of getting out of these deals. Banks are demanding that state and local governments pay tens or hundreds of millions of dollars in fees to exit these deals. In some cases, banks are forcing termination of the deals against the will of state and local governments, using obscure contract provisions written in the fine print.
By the end of 2010, according to Michael McDonald, borrowers had paid over $4 billion just to get out of the swap deals. Among other disasters, he lists these:
California’s water resources department . . . spent $305 million unwinding interest-rate bets that backfired, handing over the money to banks led by New York-based Morgan Stanley. North Carolina paid $59.8 million in August, enough to cover the annual salaries of about 1,400 full-time state employees. Reading, Pennsylvania, which sought protection in the state’s fiscally distressed communities program, got caught on the wrong end of the deals, costing it $21 million, equal to more than a year’s worth of real-estate taxes.
In a March 15th article on Counterpunch titled “An Inside Glimpse Into the Nefarious Operations of Goldman Sachs: A Toxic System,” Darwin Bond-Graham adds these cases from California:
The most obvious example is the city of Oakland where a chronic budget crisis has led to the shuttering of schools and cuts to elder services, housing, and public safety. Oakland signed an interest rate swap with Goldman in 1997. . . .
Across the Bay, Goldman Sachs signed an interest rate swap agreement with the San Francisco International Airport in 2007 to hedge $143 million in debt. Today this agreement has a negative value to the Airport of about $22 million, even though its terms were much better than those Oakland agreed to.
Greg Smith wrote that at Goldman Sachs, the gullible bureaucrats on the other side of these deals were called “muppets.”
Who could have anticipated, when the Fed funds rate was at 5%, that the Fed would push it nearly to zero?
The banks have made outrageous profits by capitalizing on their own misdeeds. They have already been paid several times over: first with taxpayer bailout money; then with nearly free loans from the Fed; then with fees, penalties and exaggerated losses imposed on municipalities and other counterparties under the interest rate swaps themselves.
The windfall of revenue accruing to JP Morgan, Goldman Sachs, and their peers from interest rate swap derivatives is due to nothing other than political decisions that have been made at the federal level to allow these deals to run their course, even while benchmark interest rates, influenced by the Federal Reserve’s rate setting, and determined by many of these same banks (the London Interbank Offered Rate, LIBOR) linger close to zero. These political decisions have determined that virtually all interest rate swaps between local and state governments and the largest banks have turned into perverse contracts whereby cities, counties, school districts, water agencies, airports, transit authorities, and hospitals pay millions yearly to the few elite banks that run the global financial system, for nothing meaningful in return.
Bloomberg’s Darrell Preston writes:
Ask a Nobel Prize-winning economist what’s the difference between the mayor of Baltimore losing taxpayer money with derivatives sold by Wall Street and millions of Americans defaulting on subprime loans and he’ll say there isn’t any: State and local governments are victims of opaque financing they don’t understand, the same way individuals go broke on borrowing at rates too good to be true.
“These financially unsophisticated local officials were being exploited by big banks,” said Columbia University Professor Joseph Stiglitz, who won the Nobel Prize in 2001 with George Akerlof of the University of California, Berkeley and Michael Spence, now at New York University, for their analysis of markets with asymmetric information.
“The outrage was not just that there were high transaction costs, but that the risk wasn’t understood by those who used them,” Stiglitz said.
Jefferson County, home to Birmingham, the state’s biggest city, became the biggest municipal bankruptcy on record after costs spiraled out of control on its auction-rate debt and related derivatives used to finance a sewer project. The county defaulted on the securities, issued in 2002 and 2003 to refinance fixed-rate sewer bonds, as short-term yields fell.
Bill Slaughter, the lawyer who advised Jefferson’s County Commission on bond sales at the time of the refinancing, said later that he couldn’t figure out the math on the swaps.
Alabama’s Jefferson County wound up in bankruptcy after it defaulted on about $3.1 billion of debt backed by sewer revenue in 2008. The financial crisis had pushed up the cost of its bonds, including the auction-rate debt, and required early repayments that the county couldn’t afford. The swaps tied to the securities also didn’t shield it from rising expenses.
Some overseas government borrowers have been banned from using swaps in their finances.
In January 1991, the U.K. House of Lords ruled that local authorities weren’t permitted to use swaps and derivatives. Parliament’s upper chamber said such agreements had “the stigma of being unlawful.” Municipal authorities, including the London borough of Hammersmith & Fulham, had speculated on the direction of borrowing costs in the late 1980s using interest-rate swaps. Auditors challenged the transactions, resulting in a series of court rulings that said such activities were outside of the council’s jurisdiction and thus unenforceable by banks involved.
In 1997, the U.K. barred local governments from investing in derivatives.
Greece used currency swaps, the biggest of which were with Goldman Sachs Group Inc., to hide 5.3 billion euros ($7.7 billion) of debt from 2001 to 2007, Eurostat, the European Union’s statistics office, said in a May report. When the arrangements were added to the nation’s accounts, it spurred a surge in borrowing costs and triggered Europe’s debt crisis.
“The banks make so much money off of the swaps, they don’t care about the underwriting fee or other fees” collected from municipal issuers, Kalotay said. In testimony at a July 29 SEC hearing held in Birmingham, he estimated that municipal taxpayers have paid $20 billion in fees on swaps valued at $1 trillion in the past five years, noting that banks usually get about 2 percent on such transactions.
And Darwin BondGraham notes:
In 2002 a little-known but powerful state agency in California and Wall Street titans Morgan Stanley, Citigroup, and Ambac consummated one of the biggest deals to date involving … an “interest rate swap.” A year later the executive director of the Bay Area’s Metropolitan Transportation Commission, Steve Heminger, proudly described these historic deals to a visiting contingent of Atlanta policymakers as a model to be emulated. Swaps were opening up a brave new world in public finance by extending the MTC’s purchasing power by $200 million, making a previously impossible bridge construction schedule achievable in a shorter timeframes. The deal would also protect the MTC from future volatile swings in variable interest rates. To top it off, the banks would make a neat little profit too. Everybody was winning.
Then in 2008 it all came crashing down. The financial system’s near collapse, the federal government’s unprecedented bailouts, and global economic stagnation mean that the derivative products once touted as prudent hedges against uncertainty have instead become toxic assets, draining billions from the public sector.
The MTC was forced to pay $104 million to cancel its interest rate swap with Ambac when the company went bankrupt in 2010. Whereas once the Commission’s swaps portfolio was saving it money, now it must pay millions yearly to a wolf pack of banks including Wells Fargo, JPMorgan Chase, Morgan Stanley, Citibank, Goldman Sachs, and the Bank of New York. The MTC’s own analysts now estimate that the Commission’s swaps have a net negative value of $235 million. This money all ultimately comes from tolls paid by drivers crossing the San Francisco Bay Area’s bridges, toll money that not too long ago was supposed to purchase bridge upgrades. Now it’s just a free lunch for the banks.
The MTC is only one example. Local governments and agencies across the United States have been caught in a perfect storm that has turned their “brilliant” hedging instruments into golden handcuffs. The result is something of a second bailout for the Wall Street banks on the other sides of these deals.
Perhaps worst of all has been the double standard set by the federal government. In 2008 when the world’s biggest banks stumbled toward insolvency, the U.S. Treasury stepped in to inject capital through the Troubled Asset Relief Program (TARP). TARP allowed the banks to offload or restructure their most toxic holdings, including many derivatives like interest rate swaps.
Four years later no such relief has been mobilized for cities, counties, and public agencies suffering from the toxic interest rate swaps they have been forced to hold. In its size and severity, the rate swap crisis rivals other discrete financial injustices related to the global economic meltdown of 2008. Unlike these other crises that have received enormous attention from the media and reform-minded officials, the foreclosure crisis for example, the rate swap crisis has remained hidden from public scrutiny, left to fester.
So why did local governments in the United States jump on the swap-wagon? The big-picture transformation of global capitalism engendered by derivatives was the last thing on the minds of local leaders as they signed rate swap agreements over the last two decades. They were feeling globalization’s local effects, however.
The post-Gold Standard era for local and state governments has … been characterized by volatile interest rates. Many local governments have been stung by wild swings in variable interest rates on bond debt. Conversely, many public entities found themselves locked into high long-term rates, unable to refinance during periodic dips. In other words, they incorrectly guessed what the price of borrowing money would be over a given time frame, and they were forced to pay the difference. In an age of chronic municipal budget shortfalls produced by tax rebellions and capital flight, a few million burned on rising interest rates, or the inability to refund debt at lower levels, is a big political deal.
Seeking to hedge against this risk, and still deliver the goods voters want, local governments eagerly signed contracts for a particular variety of swap, the floating-to-fixed contract in which cities would issue long-term debt pegged to variable rates, and then swap payments with a bank counterparty that offered the surety of a low “synthetic” fixed rate.
There was another reason for the rise in popularity of municipal swaps though. As illustrated in the case of California’s Metropolitan Transportation Commission, the promise of extending a government’s purchasing power by reducing its overall debt payments enticed many CFOs to ink swap deals. The means by which swaps could lower the cost of borrowing money for public entities hinges on the way that derivatives, as they have for global corporations, promised to create larger integrated debt markets where before there were barriers.
What swaps allowed many governments to do was to replace a floating rate with a synthetic fixed rate that was often significantly lower than would otherwise be possible if the local government itself directly issued a fixed-rate debt. Local governments tend to be able to issue slightly lower initial variable-rate debt than other sorts of borrowers (mostly large business corporations) can in other debt markets. Conversely, many banks and corporations can issue fixed rate debt at significantly lower rates than local governments have been able to. Big banks figured out how to profit from these differences with rate swaps. By issuing debt in the most favorable terms and then swapping interest-rate payments, a local government could transform its relatively low but risky variable-rate debt payment into a higher fixed-rate obligation that is lower than it would have otherwise been had the government gone straight to the market to sell fixed-rate bonds.
In March, 2010, the Service Employees International Union released one of the most comprehensive studies to date calculating how much toxic interest rate swaps have cost communities during the Great Recession. Combing through the financial reports of major cities, states, and public agencies from New York to California, SEIU researchers estimated that $28 billion had already been paid by governments to the banks, and that for 2010 alone, public entities would have to pay at least another $1.25 billion.
More recently, researchers in New York and Pennsylvania have dissected specific swap deals that have drained millions from local school systems, transit agencies, and the budgets of cities and counties. New York state and its local governments were forced to pay $236 million last year to fulfill the terms of swap agreements signed with Wall Street, according to a December, 2011 report prepared by United NY, a union-supported advocacy group. These swap payments are ultimately drawn from taxes, fees, and other sources of public revenues, diverted away from crucial services that have been cut back during the Great Recession.
Because of the economic collapse, and the decline of interest rates in 2008 to virtually zero, the MTA has been forced to pay the amazing sum of $658 million in net swap payments so far.
Philadelphia and its schools have lost $331 million in swap payments made to Wells Fargo, Morgan Stanley, Goldman Sachs, and other banks.
Other enormous transfers of public revenues to the banks include a loss of $10 million by the Bethlehem Area School District after the system was forced to cancel one particularly toxic swap. Then there’s a case that is similar to California’s MTC boondoggle. The Delaware River Port Authority, the public entity that operates and maintains toll bridges linking Philadelphia with New Jersey, lost $65 million on swap deals. As of 2010 these swaps have a negative value of $199 million for the Port Authority.
Back in California, virtually every other government and public agency has been hit by costly rate swap payments or termination fees.
In Pennsylvania the problem was identified early on by officials like the state’s auditor general Jack Wagner. Since 2009 Wagner has been imploring local and state leaders to ban their agencies from entering into interest rate swaps. Wagner’s office conducted one of the earliest (and maybe the only) official audits of swaps in the United States after the financial crisis, finding that Pennsylvania governments had entered into 626 individual interest rate swap agreements with a mere thirteen banks, linked to $14.9 billion in public debt.
the use of swaps amounts to gambling with public money. The fundamental guiding principle in handling public funds is that they should never be exposed to the risk of financial loss. Swaps have no place in public financing and should be banned immediately.
His office has so far succeeded in convincing the Delaware River Port Authority to ban itself from using rate swaps in the future, while also introducing a bill in the state legislature to ban future swap agreements by Pennsylvania governments.
Wagner’s efforts have been bolstered by the Pennsylvania Budget and Policy Center’s statewide study of swaps, referenced above. Most recently the Philadelphia City Council has convened hearings to investigate how interest rate swaps affecting the city’s agencies and school system were created. The resolution calls for the city to assess “whether corrective actions, including legal remedies, should be pursued.” Philadelphia is considering litigation to determine if banks, government employees, or advisers misrepresented or otherwise fraudulently put taxpayers on the hook for millions by obscuring the risks involved, or purposefully structuring them to implode to the banks’ benefit.
Statistics: Posted by yoda — Thu Jul 05, 2012 12:29 am
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