Barclays Libor Scandal: The Precedent

Remember, Libor is used as a benchmark for trillions of dollars worth of securities and contracts. A basis point here or there equates to literally billions of dollars — if not more — in misallocated and misappropriated funds.

There is certainly plenty of fuel in this Libor fire to stoke the rage of global investors for a long time. Emails already released acknowledge that traders involved in this manipulation knew the activity was blatantly dishonest. Yet it persisted for years. How? Why? This price-fixing scandal looks so familiar to the same sort of activity typically connected to organized crime. Those within the banks were driven to maximize profits. Those charged with regulating the markets were captured by the industry and served to protect the industry's interests rather than the interests of investors.

Ultimately, the smoke around the manipulation became too dark and overwhelming and the manipulation could not be kept under wraps. Future developments with this story are surely scaring the hell out of a lot of individuals right now. The potential for criminal charges is clearly unsettling.

Are we to believe that Wall Street has never before been involved in rigging and manipulating markets?

1. We know that Wall Street banks manipulated the auction-rate securities sector to give the appearance of a healthy market when the auctions would have otherwise failed. Anywhere else?

2. Actually if we were to go all the way back to the late 1980s and into the early 1990s, another short term rate utilized to benchmark borrowing activity was also widely believed to have been compromised.

Really? What rate was that? Let me introduce you to the 11th District Cost of Funds (COFI), which

. . . is one of many indices used by mortgage lenders to adjust the interest rate on adjustable rate mortgages. The COFI is computed from the actual interest expenses reported for a given month by the Arizona, California, and Nevada savings institution members of the Federal Home Loan Bank of San Francisco (Bank) that satisfy the Bank's criteria for inclusion in the COFI (COFI Reporting Members).

In addition to the COFI, the Bank publishes semiannual weighted average cost of funds indices for California and the 11th District.

In speaking with former traders on Wall Street we were reminiscing about the fact that this 11th District COFI index had been intentionally compromised, that is, manipulated. If my memory serves, I also recall that it was so compromised that for a period the market stopped utilizing it as a benchmark. Could the same happen with Libor in the foreseeable future?

How interesting that under Frequently Asked Questions, the Federal Home Loan Bank of San Francisco provides the following disclaimer:

Does the Bank guarantee the accuracy of the cost of funds indices it publishes?
No. Although the Bank makes a good faith effort to be accurate in the calculation and publication of the COFI and other cost of funds indices it publishes, the Bank does not warrant, confirm, or guarantee the accuracy of the data it receives from its COFI Reporting Members, the accuracy of the cost of funds calculations, or the accuracy of the cost of funds indices as published.

The Bank does not examine the books and records of its COFI Reporting Members for this purpose, and the Bank expressly disclaims all liability that may arise from any use of the COFI or other index or the use of inaccurate data received from its COFI Reporting Members in calculating the COFI and semiannual cost of funds indices. In addition, the Bank expressly disclaims any liability to any person for any inaccuracy in any cost of funds index, regardless of the cause, or for any resulting damages. In general, the Bank will not revise or republish any COFI or any semiannual cost of funds index for any reason after the publication date.

Garbage in….garbage out… sounds a lot like the practices used in the carting business.

Twenty years from now, will another massive rigging scandal ensue? Unless there are very real changes within our financial regulatory framework, I would count on it.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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