c.2013 New York Times News Service

c.2013 New York Times News Service

The Libor market, we now know, was a fraud. There were few — if any — real trades backing the indicator.

This week the scandal claimed its second top European banker and treated us to more of those delightful emails and electronic chats in which traders discuss their deceptions.

“Don’t worry mate — there’s bigger crooks in the market than us guys!” wrote an official of Rabobank, the large Dutch lender, after he agreed to a request from one of the bank’s traders in 2007 to submit a phony rate for Libor rates in yen.

He was right about that. As more cases are disclosed, there will no doubt be more big fines and more assurances from senior executives that they had no idea what was going on.

Even without fraud, Gary Gensler, the chairman of the Commodity Futures Trading Commission, said this week in a speech at Harvard, Libor rates “are basically more akin to fiction than fact.”

Unfortunately, nothing fundamental is being changed. Libor lives on. Regulators who wanted to change that, most notably Gensler, have been outmaneuvered by those who did not want to risk damaging one of the biggest and most lucrative markets around.

This week’s penitent financial institution, Rabobank, showed just how international a fraud this was. The bank settled with authorities in the Netherlands, Britain, Japan and the United States. The authorities said the fraud was carried out by more than two dozen traders and managers at the bank’s offices in London, New York, Utrecht, Tokyo, Singapore and Hong Kong. The bank’s chairman resigned.

When the Libor scandal exploded last year, with Barclays as the initial villain, there was a narrative that made the violations seem understandable and perhaps provoked at least a little sympathy for the banks. They had lied about their borrowing costs during the financial crisis, concealing how difficult a time they were having. Perhaps they should not have done so, but who was really harmed?

It turns out that the financial crisis did not cause the fraud; it merely made it so obvious that regulators finally noticed. It had been going on for years, aided by an international culture that treated market manipulation as a matter of course. If a bank did not have its own good reason for manipulating the market, then a trader would agree to do so as a favor for a trader at another institution. Why not? Maybe he would need a favor on another day.

“You know, scratch my back, yeah, and all,” a Rabobank trader said after he agreed to a request from a “geezer at UBS” to submit a figure as low as possible.

“Yeah, oh definitely, yeah, play the rules,” replied the broker who had relayed the request. The complaint filed by the CFTC, which included the exchange, helpfully explained that the “geezer” was a senior yen trader at the Swiss bank. It did not give his age.

Libor — the London interbank offered rate — is supposed to represent the costs that each bank would face if it received an unsecured deposit from another bank. Each day, banks report Libor rates for maturities ranging from overnight to 12 months, in numerous currencies. The announced Libor rates are based on averages of bank submissions. In Europe, there is a similar Euribor. Banks cheated on both.

“In the U.S.,” Gensler said in his speech, “Libor is the reference rate for 70 percent of the futures market and more than half of the swaps market. It is the reference rate for more than $10 trillion in loans.”

Such a huge market created ample incentives to cheat. Sometimes traders wanted to influence the rate so that their derivatives positions would benefit. Other times banks knew that a lot of loans they had made had interest rates that would reset on a certain day, based on a particular Libor rate. Then they wanted to push that rate up, if only for one day.

At Rabobank, the people who submitted the Libor number each day were not even trained to determine what the real market rate was. If there was no request from someone at the bank to push rates up or down, the submitters were told to just repeat the previous day’s number.

All of this makes it appear as though Rabobank got off easy, even though it will pay more than $1 billion to settle with all the prosecutors and regulators.

The CFTC settlement attributed the bank’s violations to a lack of internal controls, even as it noted that a “senior manager” was involved. The Justice Department agreed to a deferred prosecution agreement, which will enable the bank to avoid a conviction if it is not caught again.

“Rabobank has significantly expanded and enhanced its legal and regulatory compliance program,” the department explained.

Libor has always been run by the British Bankers Association. The prime change being made is to move the responsibility to the New York Stock Exchange, whose London office is preparing to take control early next year.


“As the new administrator, we plan to return credibility, trust and integrity to Libor, by bringing the essential combination of strong regulatory framework and market-leading validation techniques, administered by a pre-eminent market infrastructure provider,” the exchange promises.

But the language may not be matched by reality. When the scandal first broke, and Robert Diamond was forced to resign as chief executive of Barclays, there was talk of the need for an interest rate indicator to reflect actual transactions. But that goal fell by the roadside. The new promise is that the rate will be “anchored” in “relevant transaction data.”

What does that mean? It means that banks may use the rates they pay on certificates of deposit, or on commercial paper, or on repurchase agreements, or by observations about other markets, and adjust those rates as appropriate.


The Libor rate is supposedly a rate for unsecured loans between banks, but there do not seem to be many such transactions these days. The NYSE says that it may be appropriate for banks to use the rates they pay on insured deposits in estimating the Libor rate.

If all else fails, “expert judgment should be used to determine a submission,” wrote Martin Wheatley, whose report set the course for allowing Libor to continue without fundamental reform. Wheatley is now chief executive of the Financial Conduct Authority, a British regulator.

A spokeswoman for the Big Board assured me that the exchange “will put in place stringent surveillance systems” but will not require exact procedures.


“How they adjust other transactions is for each individual bank to take into account. The important thing is to monitor it over time, ensuring that when the relationship changes, there is good reason for the change,” she said.

In other words, rather than reflecting actual loans to banks, the Libor rate submissions can be based on any sort-of-similar transaction, adjusted in whatever way the bank thinks is fair. It is sort of like estimating gasoline prices by looking at the cost of home heating oil, or even natural gas. Traders in energy futures would never stand for that, but it is taken for granted that those who depend on financial futures will not be so finicky.


There are market rates that conceivably could have been used, as Gensler proposed. But the banks did not want to make such a big change, and it was not clear how those rates would affect existing Libor contracts.

So what will change? Presumably there will be no more incriminating instant messages, emails and taped phone calls. Traders are not that stupid. But those who submit rates will retain considerable latitude and their banks will continue to have trading desks whose profits or losses will be determined by how Libor rates change.

The frauds being prosecuted now involved interest rate manipulations of only a few hundredths of a percentage point. In the future, proving that submissions were made in bad faith could be virtually impossible.

At Rabobank, as part of the settlement with the CFTC, the people who determine what rates the bank will submit must “not be located in close proximity to traders who primarily deal in derivative products” based on Libor.

“The two groups should be separated such that neither can hear the other,” the settlement states.

So a bank that committed fraud through coordinated actions by people in six countries will assure future compliance by moving some desks around. There is no mention of a requirement that the two groups of people not use the same restrooms or drink at the same bars.