Trader 1: What's the call on the Libor?

Trader 2: Where would you like it, Libor that is?

Trader 3: Mixed feelings, but mostly I'd like it all lower so the world starts to make a little sense.

Trader 4: The whole HF [hedge fund] world will be kissing you instead of calling me if Libor moves lower.

Trader 2: OK, I will move the curve down one basis point, maybe more if I can."

Above is a conversation that took place on August 21, 2007, between traders colluding to manipulate the Libor Rate.

The Libor Fixing – now so retrospectively prescient – is a global benchmark interest rate formalised by the British Bankers’ Association in the mid 1980s. The Libor rate is determined by an average methodology of rates submitted by the Libor panel, a group of the largest most creditworthy banks with London operations, and is fixed at 11am GMT each business day. The London Interbank Offered Rate (Libor) is the reference rate at which large banks indicate that they can borrow short-term wholesale funds from one another on an unsecured basis in the interbank market.

On December 31, 2021, Libor will be phased out after more than 40 years, replaced by various other IBORs including SOFR, a secured overnight (backward looking) risk free rate based on actual borrowing collateralised by US Treasury securities.

Much happened in financial markets in August 2007.

On August 7, 2007, the international commercial paper market froze – for about 20 minutes, literally no transactions. Coincidentally, that same day, the author, just a basic financial adviser, saw this oddity while checking money market rates. Instinctively, with subprime problem rumours already appearing, you just knew this strange event was not going to end well. And it didn’t.

That was confirmed when two days later, reports indicated various foreign institutions were either halting trading in commercial paper/ money market mutual funds – due to uncertainty in pricing subprime market securities or finding fewer options in capital markets in which to redeem or sell commercial paper, began to experience serious liquidity problems. A scant few months later, the US Federal Reserve opened the swap market to foreign central banks to relieve dollar liquidity demand.

As detailed in a detailed research paper, by John B. Taylor & John C. Williams, on August 9, 2007, traders in New York, London, and other financial centres around the world suddenly faced a dramatic change in conditions in the money markets where they buy and sell short-term securities. Rates on term lending, such as the Libor one- and three-month rates, seemed to have become disconnected from the overnight rate and thereby from the Fed’s target for interest rates.

It was as if banks suddenly demanded more liquidity or had grown reluctant to lend to each other, perhaps because of fears about the location of newly disclosed losses on subprime mortgages.

As is now known, that Thursday and Friday of August 2007 turned out to be just the start of a remarkably unusual period of tumult in the money markets, perhaps even qualifying as one of those highly unusual “black swan” events.

The rest is history. With that the cascading affect (along with many other market causations) of the subprime market dislocation, global capital market security valuations began their long slide downward resonating everywhere with every investor and peripheral businesses.

The 2008 global capital market crash caught investors, credit card issuers, homeowners, millions of entities financing or guaranteeing loans, banks and financial institutions, municipalities, states, governments, ordinary people in the financial quagmire of trillions lost, as lifestyles were financially torpedoed.

All the while, actually for years it seemed, numerous traders (with their purported bank/financial institutions’ knowledge) continued to manipulate Libor interest rates on a global basis through 2008 and beyond. The discovery of these interest rate manipulations that directly benefited some, but adversely affected millions all came to eventual severe scrutiny by 2010 when Britain’s Financial Services Authority began investigations into Barclays Bank with a related review of global interest rate manipulation.

Banks were sued. By 2011 US financial institutions began filing lawsuits against numerous banks in the Libor panel from the US, UK, Switzerland, and Germany.

Banks collapsed. Money market funds were wound up, victims of subprime collateral damage. Libor settlements and fines across the board were immense, running into the billions of dollars.

Traders were prosecuted, both implementers and condoners. It is surmised that only some of them were caught, with very few convicted, while employer firms denied any knowledge.

What did this mean to the ordinary person? A one basis point fluctuation is a cent in US currency, a 1/100th per cent of an interest rate. Not much on its own, but cumulatively trillions of dollars in interest rate differentials.

Certainly, during that time there was deep distrust in capital markets, in financial institutions, in financial personnel – for a while anyway.

Made one feeling again of being a pawn in the game.

Next: New forms of benchmark interest rate effective soon.

Sources

Libor Scandal, Wikipedia

Libor: Origins, Economics, Crisis, Scandal, and Reform, David Hou David Skeie, Staff Report No. 667 March 2014

***Commercial paper is an unsecured promissory note with a fixed maturity of a few days to less than 270 days. It is traded for short term liquidity (in the trillions USD/other currencies, globally) by corporations and other entities. CP is cheaper than a bank credit line, and a major component of money market funds.

A Black Swan in the Money Market, John B. Taylor, Stanford University: John C. Williams, Federal Reserve Bank of San Francisco, April 2, 2008

The Spider Network: The Wild Story of a Math Genius, a Gang of Backstabbing Bankers, and One of the Greatest Scams in Financial History, David Enrich, March 21, 2017

Understanding the Libor Scandal, Council on Foreign Relations

• Martha Harris Myron CPA JSM is a native Bermudian Pondstraddler, author of The Bermuda Islander Financial Planning Primers now hosted on The Royal Gazette website, and financial journalist to The Royal Gazette since 2000. All proceeds from these articles are donated to the Salvation Army, Bermuda. Contact: martha@pondstraddler