In what may prove to be the “Crime of the Century,” recent evidence has come to light that some of the world’s largest banks were involved in a scheme to manipulate a key interest rate index, thereby cheating investors out of hundreds of billions of dollars.

LIBOR which stands for London Interbank Offering Rate is where 16 major international banks with offices in London each day inform the British Bankers’ Association (BBA) what each bank must pay in order to borrow cash from other banks.  The BBA then takes those rates and tosses out the highest rates and the lowest rates and averages the ones that are left and it’s published as LIBOR.  It has just become public knowledge that the banks making up the LIBOR system apparently were manipulating these rates to their advantage.

LIBOR is like the prime lending rate for banks and affects hundreds of trillions of dollars of investments in derivatives, bonds, and mortgages.  Because LIBOR is, by far, the largest interest rate index in the world, it has far reaching affects both short-term and long-term.  For example, if you had a 30-year mortgage with an interest rate set at LIBOR plus 4 percent, a few tenths of percent could cost you tens of thousands of extra dollars.  And you would be struck with that interest rate for the life of the mortgage.

Of course, the banks deny that they manipulated the LIBOR.  That’s despite the fact that Barclays Bank, a trillion dollar British bank and one of the largest in the world, had to negotiate a settlement with the British government for several hundreds of millions of dollars in penalties.  But it still claims it did no wrongdoing. Some of the biggest banks in America including Citibank, JP Morgan Chase, and Bank of America are also involved in setting LIBOR along with some of the other largest banks in the world.

The world’s major banks gained massive advantage in manipulating the LIBOR in two different ways.  The first is pretty straightforward, based upon the simple fact that these banks themselves hold trillions of dollars of investments that are LIBOR-rate sensitive.  With respect to investments that made them money if LIBOR dropped, the banks could manipulate the rate to drop when everyone in the world was expecting the rates to shoot up.  That is when the financial markets were in turmoil and the banks were exposed to massive losses.  Emails released by Barclays conclusively demonstrate that is what they did. They manipulated their stated interest rates to the BBA so as to affect the LIBOR in a way to maximize the value of their trading positions.

This is where the banks get their second advantage of manipulating LIBOR.  During the height of the 2008 financial crisis, LIBOR was viewed as a gauge of the financial strength of banks.  If the banks were charged high interest rates by other lenders who supposedly were most familiar with the borrowers’ financial condition, then it would indicate they were at a high risk of defaulting on their loans and therefore in a poor financial state.  So if a bank was actually charged a high rate of interest by another bank but falsely informed the BBA they were actually charged a lower rate, they would be looked at as a healthier bank.  This was important because, at the time, there were major investors and financial institutions withdrawing funds or refusing to lend to other institutions like Bear Sterns or Lehman Brothers.  An institution could go bankrupt in a matter of days without such investment given the heavy dependence on short term funds, the funds LIBOR was created to rate.

Now, the question of the century is, did the British government encourage the banks to manipulate the LIBOR downwards during the financial crisis?  There is some evidence that this is exactly what happened.  Barclays’ former chief operating officer, Jerry del Missier, contends that Barclays was told by the Bank of England in 2008 to underreport its borrowing costs.  He bases this on a discussion between Bank of England deputy governor Paul Tucker and Barclays’ then-head of investment banking Bob Diamond.  The subject of their discussion? Barclays’ persistently high LIBOR submissions to the BBA.

Barclays argues that Mr. del Missier misinterpreted the call, that Barclays had not been urged by the Bank of England to underreport its own borrowing costs in order to appear to be in line with other banks.  But in one transcript of a telephone call from April 11, 2008, released by the New York Fed this past Friday, a Barclays employee told the New York Fed that Barclays was underreporting its rate to avoid the stigma associated with being an outlier with respect to its LIBOR submissions, relative to other participating banks.  Another smoking gun came from a subsequent phone call, on October 24, 2008, in which another Barclays employee told a US Fed official that the LIBOR rate was “absolute rubbish”.

Under US law it’s a criminal conspiracy to falsely report and manipulate interest rates for the financial benefit of a cartel.  If the Bank of England encouraged this, then it becomes even worse.  On top of the Bank of England’s involvement, Treasury Secretary Timothy Geithner, the then-New York Federal Reserve Chairman, allegedly knew about the LIBOR manipulations in 2007.  Geithner even corresponded with the British financial services regulator as well as the Bank of England in 2008 on the LIBOR manipulations and on how to prevent them.  But nothing was done to stop the continued manipulation.

This brings into question whether Geithner, the Fed, and the British authorities can be trusted to regulate the global financial network for the benefit of the citizens.  If what’s all alleged is confirmed, this is truly a global criminal conspiracy.

Photo credit:  Matt from London