The $800 Trillion Scandal

How Banks' LIBOR Lies Affected You

By Christopher Barker, The Motley Fool

Banking scandals have grown so common that perhaps folks have simply run out of outrage. Or maybe the numbers are just too huge to wrap our mortal heads around.

Whatever it is that's behind the relatively light news coverage and lack of public debate on this incredible LIBOR rate-rigging scandal thus far, the story is not going away. In fact, it's bound to grow substantially in scope, as many of the world's largest banks have already been implicated in manipulating interest rates that are tied to some $800 trillion in loans and securities.Λ


LIBOR -- the London Interbank Offered Rate -- is supposed to reflect the average interest rate at which banks are willing to loan funds to each other. Banks submit their daily estimates of borrowing costs for various loan durations in 10 different currencies, and after tossing out the top 25% and bottom 25% of those estimates, the LIBOR rates are calculated as an average of the remaining 50% of submissions. A separate benchmark called EURIBOR tracks borrowing costs among eurozone banks.

As revelations of widespread misconduct by multiple rate-reporting banks begin to emerge, worldwide confidence in these self-reported rates has been seriously eroded, and the banking establishment as a whole has taken another major leap downward into an abyss of well-deserved public distrust.

Barclays is Just the Tip of the Iceberg

The U.S. Department of Justice slapped U.K. banking giant Barclays (BCS) with a $160 million penalty last week, declaring that "Barclays Bank's illegal activity involved manipulating its submissions for benchmark interest rates in order to benefit its trading positions and the media's perception of the bank's financial health."

Combining the penalties assessed by a trio of U.S. and British regulators, and the roughly $155 million that Barclays spent during the multiyear investigation, this one bank alone has incurred more than $600 million in charges. The bank's CEO, Bob Diamond, has resigned in disgrace, and the familiar Barclays name has been significantly tarnished.

Royal Bank of Scotland (RBS) -- the propped-up bank in which, in a royally cruel twist of fate, British taxpayers hold an 82% stake -- will reportedly be next on the hook with penalties of $233 million for its role in the rate-setting scandal. Swiss bank UBS (UBS) received "conditional immunity" from prosecution last year in return for its cooperation with the Justice Department's ongoing investigation. Meanwhile, authorities on both sides of the Atlantic are reportedly looking into potential misconduct by, among others: Citigroup (C), HSBC (HBC), Deutsche Bank (DB), JPMorgan Chase (JPM), Lloyds, and Bank of Tokyo Mitsubishi. Now that we know who some of the players are, let's examine the stakes of their dangerous game.

Why LIBOR Matters to You

By messing with the LIBOR benchmark rates that are tied to an estimated $800 trillion of securities, the offending banks essentially played with matches in the middle of the world's largest house of leveraged cards. The combined gross domestic product of all the nations of the world is only about $70 trillion, so the towering mountain of LIBOR-connected securities out there climbs into the realm of leveraged derivatives like those that nearly brought the global financial system to its knees at the height of the 2008 credit crisis. First by building that leveraged house of cards in the first place on a completely obscene scale, and then by shaking its very foundation by manipulating the interest rates on which all that paper is based, the rate-rigging banks took unthinkable risks with the fate of the entire global financial system.

Moreover, the manipulation could have affected you personally in any number of ways. If you have an adjustable-rate mortgage or an auto loan that's tied to LIBOR, the interest charged to you could have been tweaked upward or downward depending upon the direction of a particular manipulative impact.

If you own stock, the companies in your portfolio may have been cheated out of revenue from interest rate hedges. Interest on corporate debt is often tied to LIBOR as well. As Motley Fool analyst Matt Koppenheffer pointed out, Coca-Cola Enterprises (CCE) alone carries some $1 billion in debt that's tied to the LIBOR.

Pension funds, furthermore, routinely hold income-generating securities in which payments are based upon LIBOR. Municipalities likewise hedge interest rate exposures through derivatives, so your local town may have also paid the price for this horrendous behavior by the too-big-to-fail banks.

What Else Is Rigged?

A fascinating question comes to my mind as I consider the implications of LIBOR-gate: If a dozen or more banks can collectively manipulate something as central to the everyday functioning of our economic system as LIBOR, and in the process play games with an $800 trillion mountain of leveraged securities, is there any corner of our financial markets that can be deemed safe from such reckless and deceptive behavior? A number of astonishing scandals over recent years have shattered the industry's image, and collectively they portray a culture of corruption that is disturbingly pervasive.

I am utterly convinced, for example, that gold and silver prices have been routinely manipulated by certain banks to deflect attention from the weak condition of the major paper currencies. We know that a subsidiary of JPMorgan Chase is under investigation for alleged energy-market manipulation. And a slew of banks have been implicated in a municipal bond-rigging scandal that, in the words of Rolling Stone reporter Matt Taibbi, reveals "the astonishing inner workings of the reigning American crime syndicate."

I'm quite certain that plenty of good, honest people working in the banking industry are just as outraged as we are by these sorts of revelations. But unfortunately there is but one inescapable conclusion to draw from LIBOR-gate and the vast array of 21st-century banking scandals: Where opportunity and motive coincide for banks to pursue their own agenda through secretive and unsavory means, it seems far safer to presume that they will rather than to trust that they will not.