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LIBOR litigation to recoup damages after the biggest financial fraud in world history has been thrown out

A cartoon depiction of JP Morgan, the hyper-influential banker of the early 20th Century. Several of Morgan's banks and bank holding companies merged to form today what is known as JP Morgan Chase, one of the banks at the center of the LIBOR fraud.

A cartoon depiction of JP Morgan, the hyper-influential banker of the early 20th Century. Several of Morgan’s banks and bank holding companies merged to form today what is known as JP Morgan Chase, one of the banks at the center of the LIBOR fraud.

Sixteen banks at the core of the global financial system —including JP Morgan, Bank of America, and Citigroup— scored a major victory on Friday when a federal judge dismissed nearly all the charges brought against them by a group of plaintiffs that includes municipal governments, pension funds, bondholders, and other investors who lost billions of dollars as a result of LIBOR rigging. The ruling is a major setback, both legally, and financially, for those harmed by the LIBOR manipulation conspiracy. Among the most damaged are are thousands of local governments that were played like ATMs during the Financial Crisis by the banks. Banks used their power to set 3-Month and 1-Month LIBOR rates so as to extract potentially billions in interest rate swap payments from the public. Countless small investors lost equally huge sums of money as investments indexing LIBOR were rigged to pay out less. The lawsuit’s dismissal ensures that the banks will keep billions of dollars in ill-gotten gains. The ruling may also bolster the banks’ positions against ongoing investigations and settlements sought by government regulators in the US, Europe, and Japan.

Strangely, the judge’s order (available here) acknowledged the massive global fraud that caused financial damages to the public in favor a few wealthy institutions. However, Judge Naomi Reice Buchwald relied on technical legal arguments to throw out the core claims of the lawsuit. In other words, the ruling doesn’t deny that the crime occurred and that the Plaintiffs sustained serious damages, but still dismisses the claims.

“We recognize that it might be unexpected that we are dismissing a substantial portion of plaintiffs’ claims, given that several of the defendants here have already paid penalties to government regulatory agencies reaching into the billions of dollars,” concluded Judge Buchwald in her 161 page order. She justified this position, however:

“…these results are not as incongruous as they might seem.  Under the statutes invoked here, there are many requirements that private plaintiffs must satisfy, but which government agencies need not.  The reason for these differing requirements is that the focuses of public enforcement and private enforcement, even of the same statutes, are not identical.  The broad public interests behind the statutes invoked here, such as integrity of the markets and competition, are being addressed by ongoing governmental enforcement.”

Government regulators have already proven through their own investigations that LIBOR was rigged to enrich the banks at the expense of their customers and counterparties who entered into LIBOR-linked derivatives contracts, or purchased LIBOR-referencing securities. Beginning as early as 2005 Barclays, a member of the British Bankers Association, submitted false quotes to Thompson-Reuters, the company responsible for calculating and disseminating the different LIBOR rates each day. The false quotes were designed to skew LIBOR upward, or downward, by precise amounts, so as to benefit the positions of Barclays traders against their counterparties. In doing so Barclays violated securities laws and committed a fraud that harmed countless other market participants relying on LIBOR to value their financial deals.

To date Barclays, UBS, and the Royal Bank of Scotland have all paid fines for manipulating LIBOR rates. A Japanese subsidiary of UBS even pled guilty to criminal charges, but regulators targeted only the Japanese subsidiary so as to leave the Swiss holding bank UBS legally unscathed. The fines for these three banks totaled only $2.5 billion, probably much less than they gained by manipulating various LIBOR rates for more than a half decade. None of the banks have been criminally charged. Even so, Judge Buchwald said that authorities are adequately investigating and punishing the financial companies, and that civil litigation to recoup money and impose penalties does little to advance justice.

During the Financial Crisis beginning in late 2007, and through 2010, the banks manipulated 1 and 3-Month LIBOR rates downward in order to both give the impression that they were weathering the global liquidity crisis, and that investors should not withdraw their money or sell bank stock. (LIBOR is supposed to gauge the rate of interest at which a bank can secure a dollar loan from one of its peers, so lower rates appear to indicate a healthier bank balance sheet.) As credit markets froze up in 2007 and 2008, the banks hunted for cash to close out trades on losing positions and settle hefty credit default swap obligations, among other ballooning liabilities. The banks extracted bigger payments from their counterparties on swaps, and other derivatives contracts that use LIBOR to calculate interest rate payments, by further depressing LIBOR.

Much of this cash was squeezed from cities, counties, public schools, public hospitals, public utilities, ports, airports, and other agencies that purchased interest rate swaps to convert variable rate bond debt into fixed rates. The manipulation of LIBOR since 2007 likely impacted swaps hedging hundreds of billions in public debt, causing billions in inflated payments by local governments to the banks.

The City of Baltimore was a big purchaser of interest rate swaps used to hedge bond debt. Baltimore also purchased and held other LIBOR-linked derivatives as investments. Baltimore lost millions of dollars as a result of LIBOR manipulation, and filed its lawsuit against the banks in August of 2011. Other local governments soon joined Baltimore, creating a class action group of plaintiffs that potentially included hundreds or thousands of local governments across the United States.

Bondholders and other securities investors filed their own separate lawsuits alleging fraud and damages due to the bankers’ conspiracy. All of these cases were consolidated before Judge Naomi Reice Buchwald in the Southern District Court, District of New York in 2012.

The local governments united behind Baltimore —including most recently the California cities of Richmond and Riverside, and counties of San Diego and San Mateo, as well as the East Bay Municipal Utility District, all of which filed their own lawsuits early in 2013— sought to recoup damages from the banks by using US anti-trust, and anti-racketeering laws under the Sherman Act, Clayton Act, and the RICO Act. Judge Buchwald ruled, however, that the Plaintiffs cannot sue under these laws because they have not sustained anti-trust damages, among other reasons.

With respect to the anti-trust allegations, Judge Buchwald argued that LIBOR was never a “market” rate that banks competed among one another to set. Instead, Buchwald notes, rightly in fact, that LIBOR was a non-market endeavor that did not reflect an actual rate the banks borrowed money at, but a rate at which the banks claimed they could borrow money from one another. Because the banks were not in competition with one another to produce LIBOR, they cannot be said to have suppressed competition, or manipulated the market. The damages sustained by local governments as a result of LIBOR rigging cannot technically be said to have resulted from an anti-trust conspiracy, said Buchwald.

So even though the banks dishonestly rigged LIBOR, resulting in huge financial damages to countless counterparties and investors, under Buchwald’s reasoning the banks have not violated the letter of the Sherman Act and US anti-trust law. According to Buchwald:

“Regardless of whether defendants’ conduct constituted a violation of the antitrust laws, plaintiffs may not bring suit unless they have suffered an “antitrust injury.”  An antitrust injury is an injury that results from an anticompetitive aspect of defendants’ conduct.   Here, although plaintiffs have alleged that defendants conspired to suppress LIBOR over a nearly three-year-long period and that they were injured as a result, they have not alleged that their injury resulted from any harm to competition.  The process by which banks submit LIBOR quotes to the BBA is not itself competitive, and plaintiffs have not alleged that defendants’ conduct had an anticompetitive effect in any market in which defendants compete.  Because plaintiffs have not alleged an antitrust injury, their federal antitrust claim is dismissed. “

This of course will come as a surprise to close observers of the financial system; LIBOR became the underlying interest rate of reference for the global derivatives market precisely because it was assumed that it was an honest determination of the rate of interest, or price, which banks charge one another to secure dollar denominated loans. Indeed the motives of some of the banks to depress their individual LIBOR quotes between 2007 and 2010 indicates that each bank’s individual quote was compared to other banks to gauge the company’s health, making it a somewhat competitive measure of credit worthiness. Countless financial workers, from CEOs to floor traders, have assumed for years now that LIBOR was a market rate. Even Bloomberg News, the financial industry’s favorite online news and data source, lists LIBOR under its “market data” tab.

But even if LIBOR had taken on some pseudo-market characteristics, and even though it was believed to be an honest determination of lending rates, Judge Buchwald is correct in noting that LIBOR was never a mechanism of the “free markets” which anti-trust laws are designed to regulate. Instead, as I have pointed out elsewhere, LIBOR was always “a club of powerful banks inventing the price of money, and expecting that other banks, corporations, and even sovereign states would accept their word.” This raises a fundamental question that the LIBOR lawsuits have proven incapable of addressing. Because they are predicated on anti-trust laws, these lawsuits assume free markets in which some participants abused ill-gotten power to distort otherwise fair prices. The current financial system is not a “free market,” and bank rates are inherently political in nature.

The second law around which Baltimore and other local governments built their case was the Racketeering Influenced and Corrupt Organizations Act, better known as RICO. Here Judge Buchwald ruled that the Plaintiffs have no case against the banks under RICO, first because of a 1995 law that virtually exempts financial criminals from being subject to RICO law, and because of the global nature of the crime.

The Private Securities Litigation Reform Act (PSLRA) was written by the financial industry and passed after an intensive lobbying effort that included spending millions on the elections campaigns of both Republican and Democratic Senators and Representatives by the world’s biggest banks. Under the PSLRA, crimes by financial companies that would otherwise be subject to RICO, are instead exempted under the rationale that they are better dealt with under securities fraud law.

The PSLRA also made it more difficult for scammed governments and customers to sue powerful financial companies; securities fraud lawsuits can only be filed and advanced with strong evidence of wrongdoing before trial. RICO lawsuits, on the other hand, can be filed with less evidence, relying on the pre-trial discovery process to turn up more facts and build a stronger case. This informational asymmetry that greatly disempowers the public, and small fish in the financial markets, and favors the big banks, brokers, and traders, was precisely the point of the PSLRA, and even though President Clinton vetoed the law upon its passage in 1995, the Congress, in a rare show of bi-partisan cooperation, and swimming in financial industry cash and influence, overturned his veto.

As if this legal roadblock isn’t enough to kill the RICO claims, Judge Buchwald added that the global nature of the LIBOR fraud exempts the crime and the criminals from prosecution under RICO. “RICO applies only domestically, meaning that the alleged “enterprise” must be a domestic enterprise,” ruled Buchwald in her decision. “However, the enterprise alleged by plaintiffs is based in England,” where the British Bankers Association is based, and where Eurodollar securities are traded. So in this case the global nature of the financial system serves to put the banks beyond the reach of the US law.

Judge Buchwald relied on other technical aspects of federal and state laws to dismiss the LIBOR Plaintiffs’ claims, including the the statute of limitations under the Commodities Exchange Act. The CEA’s statute of limitations is two years from the point in time that the harmed parties become aware of the potential crime. Under a complicated chain of reasoning including the publication dates of various press reports and academic articles raising doubt’s about LIBOR’s assumed validity, Judge Buchwald dismissed any claims against the banks stretching back to manipulation of LIBOR prior to May 29, 2008, and barred most other possible claims related to LIBOR manipulation before April 15, 2009, leaving virtually only instances of LIBOR rigging after that date as crimes that the Plaintiffs can sue for damages over.

The Plaintiffs bringing the LIBOR lawsuits forward could not be reached before press time, but they still have the ability to appeal the decision if they so choose.

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Oakland’s leaders are currently investigating how the conspiracy of a few global financial companies to rig the London Inter-Bank Offered Rate affected the city’s finances. Sources in City Hall say that the theft may amount to more than $300,000.

Oakland’s losses are due most likely to interest rate swaps the city agreed to with several banks in the mid-2000s. In 2004 Oakland sold $117 million in variable rate bonds. The underwriters of these bonds, Bank of America and UBS attached interest rate swaps to these variable rate bonds. The swap payments involved a two way flow of funds between the city and the banks that was intended to convert the variable rates on the bond debt into a “synthetic” fixed rate.

Under the terms of the two deals with Bank of America and UBS, Oakland paid the banks 3.533 percent, and in return the banks paid 58 percent of the 1-Month LIBOR rate, plus a “spread” of 350 basis points (0.350 percent). The LIBOR-linked rates the banks paid Oakland were intended to mimic the variable rates on the bonds, thus passing through Oakland to service the bond debt, leaving Oakland paying the fixed rate of 3.533 percent (thus the “synthetic” label).

However, because UBS, Bank of America, and other banks that were part of the panel that set the different LIBOR rates, rigged LIBOR downward over various years, Oakland ended up paying more than it should have. It was theft, plain and simple, even though it occurred through a complex financial architecture invisible to most.

The terms of Oakland’s interest rate swap agreements with UBS and Bank of America can be viewed online here.

To assess just how much money was stolen from Oakland by UBS and Bank of America we must determine when, and by how much the banks manipulated the rates, and in what direction. Financial analysts employed by many local governments and public agencies are currently doing this tedious work, including inside Oakland’s finance and legal offices.

To help the public understand how the conspiracy worked, and just how much it may have affected Oakland, I’ve calculated the following guesstimate.

Let’s assume that since 2004 the banks rigged the LIBOR rate downward by an average of 50 basis points at any given time. This is a really sloppy and imprecise assumption as the banks might have rigged the rate upwards and downwards over time depending on what rates would have benefitted them in the ever-shifting world of finance. Rigged rates could have been jacked up a lot during some periods, while only a little bit during other periods, or downward by big and small margins. For the sake of simplicity let’s just assume the average impact of the LIBOR rigging conspiracy over the terms of Oakland’s swaps with UBS and Bank of America was negative 50 basis points, or -0.05%.

The following table shows what Oakland probably actually paid between 2004 when the swaps were signed, and 2008 when the city terminated the swaps (they were originally intended to run to 2026). Assuming the LIBOR rate wasn’t rigged would mean that after netting out Oakland’s fixed rate against the bank’s LIBOR-linked variable rate, Oakland paid the banks approximately $7.7 million.

OaklandActualSwapPayments

If LIBOR during this period was skewed on average by negative 50 basis points by the banks, it would mean that the variable rates paid by the banks to Oakland were lower. Under this scenario the net flow of payments would have been even further in the favor of the banks. The following table adds fifty basis points back to LIBOR, simulating what the banks should have paid in the absence of the conspiracy. Under this hypothetical scenario the banks should have only received $7.45 million from Oakland.

OaklandIdealSwapPaymentsAssumingLIBORRigging

The difference of a quarter million here is the amount that the banks might have stolen from Oakland.

Then there’s the termination payment that would have been made in the Spring or Summer of 2008 by Oakland to close out the swaps. These termination fees are calculated using the “fair value” of the swap. The swap’s value depends on where LIBOR is at, and where it’s trending. Thus if the banks had been rigging LIBOR downward over time, and pressing down very aggressively during the financial crisis, Oakland’s termination payments would also have been skewed in the favor of the banks. So an estimate of $300,000 seems to be a reasonable, if conservative, estimate of how much was stolen from Oakland by UBS and Bank of America.

cityoflondon

The City of London, the world’s most central financial hub and site of the biggest Eurodollar money market which LIBOR was created to govern.

The importance of uncovering the complete truth about the LIBOR rigging conspiracy cannot be overstated for local communities across the United States, especially here in California.

It’s been five years since a few academics and journalists began to dig up evidence that something was wrong with the London Inter-Bank Offered Rate, or LIBOR (pronounced appropriately as “lie-bore.”) The data that curious researchers were compiling couldn’t be explained using the prevailing definition of what LIBOR supposedly was: a trustworthy interest rate that accurately gauged the market price of borrowed US dollars held overseas by the world’s biggest banks. Instead, their findings pointed toward something other than an idealized neoliberal market, influenced only by impersonal supply and demand forces. Many began to realize that the data could easily be explained if the banks were rigging the LIBOR rate in their favor. Strange discrepancies in LIBOR’s correlation to other rates, and to the economic fundamentals of the bank companies responsible for formulating the rate, showed something seriously amiss, but it made sense if the banks were cheating.

The motives of the banks have been clear from the beginning. A few banks that dominate the marketplace for derivatives stand to make billions if LIBOR moves in their favor on particular days when contractual payments between them and their customers come due. They therefore suppressed the rates in order to skim billions of dollars off derivatives and investments. Later these same banks suppressed LIBOR rates to create the illusion that their balance sheets were robust during the financial crisis. This also allowed them further rounds of money-siphoning from their unwitting derivatives customers.

Barclays-logoUntil recently LIBOR rates have been set by a panel of banks that are members of the British Bankers Association (BBA). The BBA is a private industry group established almost 100 years ago to lobby for the financial industry in one of its global hubs, London. The BBA really came into power in the mid-1980s with the creation of LIBOR. LIBOR was created to further integrate the giant global money market in US dollars held in overseas banks or holding companies, and therefore unregulated by the US Federal Reserve. Called “Eurodollars,” because they originally were dollar savings accumulated in European banks, especially banks in London, these funds quickly became a de facto global currency. LIBOR began as a way for the banks to standardize investment products for these vast pools of American dollars flowing through Europe, and later Japan, the Middle East, and Latin America. By the 1990s LIBOR had become such an important set of interest rates, and US dollars held overseas had becomes such an important source of credit for US consumers, that LIBOR became the key global interest rate around which many financial products were pegged. As LIBOR became more and more important to the globalization of finance, it accrued a sort of official, trusty gloss; nearly everyone assumed that LIBOR was a market rate reflecting competition. Instead, LIBOR has probably all along been a fudged rate, determined less by vast market forces and invisible hands, and more by the vulgar self-interest and power of the elite banks that set LIBOR rates.

citiLast year government investigations into this globe-spanning crime —rightly called the biggest financial scam in all of history— led to multi-billion dollar fines against Barclays, the Royal Bank of Scotland, and UBS, the 7th, 8th, and 20th largest banks in the world, respectively. Criminal investigations spearheaded by US, UK, Japanese, Canadian, Swiss, and Singaporean authorities are ongoing and aimed at other banks such as Citigroup, JP Morgan, Bank of America, and other “too big to fail” institutions. More details of the crime will be forthcoming as e-mails, internal documents, phone tapes, text messages, and other evidence, is made public, and as the banks are forced to pay significant fines, and sign plea agreements.

While this scandal might seem worlds away, concerning complex financial concepts and obscure money market instruments dealt by bankers out of skyscraper offices in the City of London, the importance of uncovering the complete truth about the LIBOR rigging conspiracy cannot be overstated for local communities across the United States, especially here in California.

ubsWhy? First, LIBOR has been used since the 1990s to determine cash flows on interest rate swaps that local governments have purchased from banks to insure themselves against wild swings in variable interest rates owed on billions of municipal debt. Messing with LIBOR messes with the payments due on these instruments.

Second, LIBOR has also been used as a main interest rate of reference for an array of investment products that yield a variable return, dipping and rising in concert with LIBOR. Local and state governments have used these investment products, called “municipal derivatives reinvestment products” to temporarily park public funds, while pension systems and government enterprises like utilities use them make investments. Governments and public agencies earn LIBOR rate returns on their dollars invested in numerous kinds of municipal derivatives, so if LIBOR is illegally fixed downward, they earn less income.

jp_morgan_chase_logo_2723Through both of these forms of exposure, local governments have potentially been harmed by LIBOR-fixing perpetrated by the banks, often times the very same banks that have sold them swaps or municipal derivatives investment products.

California is fast emerging as a center of investigation and litigation into the LIBOR-fixing conspiracy. California is the largest single municipal debt market in the United States, and one of the largest in the world. Last year alone the state of California and its cities, counties, school districts, and other public entities issued $65.7 billion in total public debt. Because of California’s regressive tax structure and chronic budget crises, the state’s multitude of governments have been among the most aggressive in issuing variable rate debt hedged with interest rate swaps.

The Golden State’s local governments have also been the largest purchasers of municipal derivatives contracts from banks because streams of tax and fee revenues often don’t match up with the dates that payments to public employees and contractors come due. Collusive suppression of LIBOR rates by the 16-member panel who were trusted to provide accurate quotes could mean that California local governments have paid untold millions to their interest rate swap counterparties (the banks) that should otherwise have remained in budgets and used to fund school construction, bus lines, street paving, water and sewerage services, etc.

In the 1990s and 2000s local governments across California increasingly issued bonds with variable rates. Investment bank underwriters and municipal debt advisers from the private sector encouraged variable rate bond financing because it promised lower interest rates for California’s cash-strapped municipalities. To hedge against the risk that variable rates might explode, as they did in the 1980s, the banks sold interest rate swaps to local governments. The swaps effectively converted floating rate debt into a fixed rate. Under a typical swap contract the bank seller agrees to pay a floating rate designed to mimic the variable rate interest on the bond debt, and in return the local government agrees to pay a fixed rate. I’ve written elsewhere about how this deal blew up and created a financial injustice when variable interest rates plummeted during and after the Financial Crisis, but the LIBOR rigging conspiracy adds to these harms. The US government bailed out the banks and assisted them in taking “toxic” derivatives assets off their hands, but stood idly by while cities, counties, and public agencies suffered without aid during the Financial Crisis, allowing derivatives instruments on the public’s books to blow up and drain budgets. At this very moment the banks perpetrated an illegal scam to suck even more money from the public via further depression of LIBOR.

Barclays, RBS, UBS, and other banks worked together to suppress LIBOR below even the depths to which it sank after 2008. A number of lawsuits filed by various cities, counties, and public agencies in California asserts the banks did this to skim off an unknown, but very large, amount of money from their public victims, and also to bolster their own balance sheets during the crisis. By suppressing LIBOR the banks ensured that the net difference between the variable rates they owed, and the fixed rates the public was paying on swaps, was wider than it would otherwise have been. This net difference meant that the public owed the banks higher amounts when the interest rate swap payments came due (usually twice a year).

For San Francisco this could mean that millions have been stolen from the capital budget of its Airport. SFO currently has seven interest rate swaps it has purchased to convert variable rate bond debt into synthetic fixed rates. The airport’s counterparties on its swaps included JP Morgan Chase, Merrill Lynch (owned by Bank of America), and Goldman Sachs. Each of these banks likely benefited from conspiratorial suppression of LIBOR, even if it was by just a few basis points (hundredths of a percent). JP Morgan Chase and Merrill’s parent Bank of America are both members of the panel that sets LIBOR, and are both believed to have played a role in the conspiracy.

San Francisco’s pension system may have also been raided by the banks through its speculative investments in swaps. According to the most recent audit of the San Francisco Retirement System’s portfolio, the city’s pension system holds two interest rate swaps on its books with a notional value of $15 million. In prior years, SFERs held other swaps. In 2010, the Retirement System’s audit showed three interest rate swaps with a total notional value of $41 million. Over the last two years these swaps drained $5.3 million from the pension system, and some of these losses might have been due to the downward manipulation of LIBOR. Also on the Retirement System’s books are other investments in bank loans, options, and other securities that might have been impacted by the LIBOR fraud.

San Francisco’s LIBOR damages are probably small in comparison to other local governments and public agencies. The East Bay Municipal Utility District has already filed a lawsuit in federal court alleging damages from bank rigging of LIBOR. The water district’s complaint, filed in January of 2013, alleges that LIBOR suppression drained potentially millions, again from interest rate swap agreements with some of the very banks that sit on the LIBOR-panel: Citibank, JP Morgan Chase, and Bank of America. East Bay MUD lists nine interest rate swaps potentially affected by LIBOR rigging in its lawsuit.

East Bay MUD’s swaps had a total notional amount of $481 million in 2012, according to the utility’s most recent financial report. Downward manipulation of LIBOR by just 10 to 50 basis points (1/10th to 1/2 of a percent) could have drained between $481,000 to $2,400,000 through East Bay MUD’s swap payments every six months. Over a few years, say the conspiracy’s 2007-2010 time-frame alleged in EBMUD’s lawsuit, this would add up to millions of dollars stolen by the banks.

EBMUDswaps

The cities of Richmond, San Diego, and Riverside, and the County of San Mateo, are other California governments that have now filed lawsuits against the banks responsible for setting LIBOR. All of these lawsuits have been consolidated into a larger class action case currently being heard in the U.S. District Court, Southern District of New York, before Judge Naomi Buchwald. There are now about two dozen LIBOR manipulation lawsuits that have been filed and consolidated in New York. The lead case is the City of Baltimore and the New Britain Firefighters’ and Police Benefit Fund lawsuit against the 16-bank LIBOR panel, filed in April of 2012.

More California cities, counties, and public agencies are expected to file their own lawsuits soon, however. CalPERS, which has numerous investments that fluctuate in value and yield with LIBOR, is also said to be investigating its own exposure to rate rigging.