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Libor: the saga of recession continues

Kingshuk Nag
EVERY time a catastrophe is reported in the financial markets, invariably banks have a role to play either directly or indirectly as such bankers have earned a new title, bankster, with the suffix possibly hired from the word scamster. Lately, a scandal has put the banking industry in tenterhooks and additionally the human resources function of the banks in overdrive. It surely must be hard work issuing mass pink slips to blemished traders in the wake of the Libor scandal which some consider as “The Grime of the Century”. Surely someone for the stature of Bob Diamond, who led Barclays to being one of the top international banks in just over a decade, signing the pink slip is just a precursor to the global headwinds faced by the banking industry.
Until news of the Libor manipulation broke across all forms of media, we thought that the financial markets were going through a serious breakdown and a resultant of threadbare economic decisions. But now signs of dishonesty and greed are seen as the major drivers in pushing the global economy to its deepest trench ever. However, the suppression of the Libor rates was brought to the knowledge of the regulator)' bodies on both sides of the Atlantic as and when it happened by Barclays in early 2008. Nevertheless, the revelation that the suppression was carried out allegedly on the orders of Paul Tucker, deputy governor of the British Central Bank, to ease tensions on the financial stability of the broader economy is nothing but startling. Consequently, it is becoming more and more difficult to escape the questions post the Libor scandal especially if your livelihood arises from one of the cubicles stationed in the dizzy structures of Canary Wharf.
Libor or the London Inter Bank Offered Rate is a lending rate benchmark at which banks can borrow and lend funds among each other. Every weekday, member banks of the British Banker's Association (BBA) submit a rate to the BBA that they would pay if they sourced funds from another bank by 1 lam London time. Thomson Reuters on behalf of the BBA calculates the benchmark rate by dumping the top quarter and the lowest quarter and averages the residual submissions. Banks usually quote Libor plus an additional percentage on borrowings and the additional percentage is a reflection of the creditworthiness of the borrower. As a result of loans and derivatives being tied to the Libor worth hundreds of trillions of dollars, any manipulation in the Libor rate will invariably lead to a financial mess.
On June 28, Barclays, UK’s second biggest bank, was levied a hefty fine of $450 million after it admitted to charges of false submissions in Libor and Euribor rates between 2005 and as late as 2010 according to the notice given by FSA UK. Every day a team of submitters at Barclays as per the liquidity situation in the market decides on the rate it will pass on to Thomson Reuters for the estimation of the final Libor rate and the submitters are supposed to act autonomously. However, the derivatives traders at Barclays made numerous requests to influence the rate to be submitted to Thomson Reuters on the basis of their long/short positions. The FSA examined 111 such requests made by the derivatives traders to the submitters between 2006 and 2007 and
more than 75 requests were entertained by the submitters. Such requests in exchange for a cup of coffee were not only limited to insider requests but also from traders of other banks who offered a higher bait in the form of an exquisite Bollinger champagne.
Such requests that altered the submissions by a basis point were enough for any bank to pocket a couple of million dollars given the size of the contracts in the derivatives market. Although reports reveal that traders fiddled with the benchmark rate to earn higher profits, it is also true that it was done to ease tensions that majority of the banks suffered from liquidity crunch post the Lehman Brothers crash. Libor is a major indicator on the financial health of markets and if Libor goes up, so does the anxiety among market participants. At the height of the economic crisis in 2008 when the Libor was rigged by market partici- pants, the rate reached a high of 6.25 percent reflecting the uneasy situation of banks to lend among each other. Apart from these, Barclays traditionally submitted higher rates much to the dismay of the market participants and was compelled by the negative press to eventually submit lower rates.
A combination of market good, individual gain and synchronisation with market rates by Barclays led to widespread tampering of the benchmark interest rates. The fiddling of the rates happened in collusion with other market participants that depicted a pseudo picture of the health of the financial markets during the Lehman crisis.
As such trillion dollars worth of derivative instruments, loans and mortgages tied to the Libor are expected to lose or gain money out of the unrestrained setting of the world's most widely used benchmark interest rate. For instance, a US mortgage borrower on one hand would be paying lesser monthly instalments and on the other would get lesser interest income if his pension funds lent money to the banks due to the suppressed lower interest rate. Already hundreds of pension funds, states and cities in the US are counting the costs and leading the crusade is Baltimore City in the US claiming to have been “robbed” of millions of dollars. Nonetheless, it remains to be seen whether the mortgage borrowers who doled out lesser interest payments will be kind enough to calculate their profits and give it back to the greedy but needy banks.
Amid the sheer ruckus in the financial markets, one section of professionals are facing insatiable demand for their skills as legions of attorneys are expected to represent their clients in filing and defending a series of lawsuits against or for the banks depending on the sides they choose to stick with. Cities, pension funds and hedge funds in the US are already lining up in federal courts to recover their profits lost due to the suppression of the benchmark interest rate. More than a dozen banks valued at trillions of dollars are under the scanner and the lawsuits threaten to push the profitability of the banks out of the window landing them in huge debts in order to settle the lawsuits. This in effect will potentially turn the road to global economic recovery off track and should be enough to bring back memories of the Great Depression to life.
The writer is a banker and can be reached at kingshuk_nagOO1 @yahoo.com.