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"Same Old Boring Story"

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The Barclibor scandal waits for no man; the municipal borrowers have had their day in the sun and now we move on to the New York Fed's disclosures about what it knew when. Short version: everything, immediately! Here is a thing that a Barclays trader told a NY Fed economist in April 2008 (omitting the economist's "Mm hmm"s and "Yeah"s*):

[Barclays]: Dollar, Dollar LIBORs do not reflect where the market is trading which is you know the same as a lot of other people have said. Um, wha-, it depends on which part of the curve you’re looking at. Um, currently, we would say that in the three months, um, if we as a prime bank had to go in the interbank market and borrow cash, it’s probably eight to ten basis points above where LIBOR is fixing. If, if, if we had to go in the market and properly borrow money, it would be about eight to ten above and in the one year it would probably be about twenty basis points in the market.

[Fed]: And, and why do you think that there is this, this discrepancy? Is it because banks maybe they are not reporting what they should or is it um ...

[Barclays]: Well, let’s, let’s put it like this and I’m gonna be really frank and honest with you.

[Fed]: No that’s why I am asking you [laugher] you know, yeah [inaudible] [laughter]

[Barclays]: You know, you know we, we went through a period where we were putting in where we really thought we would be able to borrow cash in the interbank market and it was above where everyone else was publishing rates. And the next thing we knew, there was um, an article in the Financial Times, charting our LIBOR contributions and comparing it with other banks and inferring that this meant that we had a problem raising cash in the interbank market. And um, our share price went down. So it’s never supposed to be the prerogative of a, a money market dealer to affect their company share value. And so we just fit in with the rest of the crowd, if you like. So, we know that we’re not posting um, an honest LIBOR. And yet and yet we are doing it, because, um, if we didn’t do it it draws, um, unwanted attention on ourselves.

I don't know how to take the laughter at the Barclays trader's promise to be honest with her. It's not like they were being dishonest with anyone else (except BBA!). Here are things that Barclays' money markets desk sent out in client commentary, copying the World Bank, ECB, and New York Fed:

[September 26, 2007] Same old boring story. Day to day money is trading very cheap, the quarter end turn is looking relatively well bid at 5.20-5.10. There is liquidity in one to six months but our feeling is that libors are again becoming rather unrealistic and do not reflect the true cost of borrowing.

[October 3, 2007] 3 month libor rose 1 bp yesterday. It should have risen more. One libor contributor set it 2 bps lower than where they were paying at 11 am!? The credit squeeze is still with us although money is available at a price.

There is just not a lot of secrecy here: Barclays talked about Libor as a manipulated fiction in mass-distribution emails to money market product clients and regulators, in a way that makes it clear that they thought they were just stating the obvious. This is not a "we have some evidence that Libor is wrong" research report. This is a throwaway line, "of course Libor is manipulated but let's look at it anyway," in a daily update going to basically everyone in the money market.

Of course it wasn't going to everyone who used Libor: nobody told Nassau County "hahahaha you're getting screwed on your swaps because Barclays doesn't want to look bad." But I think these Fed documents make it hard to share the collective amnesia of thinking that Libor was the most important and trusted thing in the world until it was broken by a secretive coterie of bankers and nobody knew about it. Everybody knew about it.

One thing that they knew specifically was that Libor, in Mervyn King's great phrase, was “the rate of interest at which big banks don’t lend to each other”: it had to be fudged, because there often weren't any actual trades from which to determine the rate at which banks borrow from each other.** So banks had to submit Libors that were, like the man said, "within pre-established price testing thresholds around external 'mid-market' benchmarks," except without the thresholds.

This seems to have been clear to everyone - banks, money-market investors, regulators, the BBA, academics, everyone - during the financial crisis, and they understood that that would mean the potential for fudging, and they further understood that the direction of fudging would be down. And they were okay with that, it seems to me, for reasons not unrelated to why they were okay with things like lower Fed target rates, or bans on short sales of banks, or very slow and incremental credit-ratings downgrades of banks. They thought the fudging would make the crisis better.

Now of course things look worse in part because memories are short, in part because so are statutes of limitations, and in part because the people affected negatively by lower Libor rates are starting to figure out what everyone else knew in 2007. But I suspect that, just as it was in the JPMorgan restatement, the real question is about intent.

These NY Fed documents actually don't sound that bad: they sound like thoughtful people trying to report reasonable borrowing rates while being mindful of market stability, and discussing that balancing act openly with their regulators. The earlier Barclays emails, in which derivatives traders asked Libor submitters to change their rates to help the swap book, sound terrible: market manipulation for high-fives and profit. Mis-marking within a reasonable range is not necessarily a scandal; in some sense it's most of what most traders do most of the time. It only becomes a scandal when you do your mis-marking for nefarious purposes, with "hiding trading losses" and "screwing derivatives counterparties" being reasonably obvious nefarious purposes. "Keeping our name out of the FT and our stock price out of the crapper" is a gray area: it doesn't seem to have looked that nefarious in 2007-2008, but now maybe it does.

The problem for regulators seems to be that the FSA and CFTC really wanted to go after the Barclays derivatives traders who clearly intended to manipulate Libor for their own profit. But since everyone knew that Libor was manipulated in 2007-2008, and that those manipulations dwarfed in magnitude the nefarious profitable manipulations,*** regulators couldn't go after the latter without also going after the former. And so they did: the Barclays complaints start with the derivatives scheme and move right into the 2007-2008 stabilize-the-banking-system scheme.

But they probably don't want to do that. For one thing, it makes the regulators themselves look bad: instead of "look what we caught with our diligent investigation," the story becomes "look at all the times we were very explicitly told about this and didn't stop it."

But going after all the Libor manipulations also expands the damage to banks. I don't find it hard to believe that a lot of banks had better Chinese walls than Barclays did, and weren't going around adjusting their Libor submissions to benefit their trading book.**** I find it easier to believe that every, or almost every, Libor agreed with Barclays' that "it’s never supposed to be the prerogative of a money market dealer to affect their company share value [down - ed.]." If every bank did in fact lowball Libor, then every bank has potential liability, and you start getting absurd numbers like $22 billion being sucked out of banks and given to a still-assembling crew of hedge funds, corporates, municipalities, regulators, and (mostly) lawyers.

New York Fed Responds to Congressional Request for Information on Barclays - LIBOR Matter [NY Fed]
New York Fed Says It Knew Barclays Underreported Libor [Bloomberg]

* Of which there are many. But from the transcripts, and her LinkedIn page, I suspect she was a bit more market-savvy than Peggy, another New York Fed employee who had this glorious exchange on October 27, 2008:

Peggy: Hi. I'm sorry for bothering you I just want to get a quick update on how dollar funding conditions are.

[Barclays trader]: Um, well I suppose the name of the game today ahh is emerging markets, ah and everyone is sort of worried about emerging markets and lack of liquidity therein. We're hearing overnight Romanian trading at anything up to 900% ... ahh .... overnight Mexico's trading up in the hundreds as well, so it's sort of ... that's sort of causing a bit of a problem for the dollar market in .... well for every market, it's not just the dollar market in that people are just very, very worried about sort of counterparties, liquidity, all the general thing that we were worried about last week. Now the one bright note on the horizon (we don't like to be negative all the time) is the CPFF.

Peggy: Yes. Starting today. Okay.

Everyone who has ever called a trader during market hours has had a conversation like this. After Romania I was disappointed that he went with Mexico as opposed to, like, Molvania.

** Some of the Barclays trader calls with the Fed discuss this; in Peggy's call from October 2008 a trader discusses getting 1-month money at between 3.25% and 3.40% and submitting 3.40% for Libor but "I could have probably put that five ticks down and that would have been ... and you know I couldn't have argued against it." And he was unable to borrow 3-month money, after trying and failing to lift a 3.75% offer, and so submitted a 3.90% 3-month Libor "really because, just, because there is no money out there."

*** Barclays told the Fed about 8-10bps of understatement for three-month Libor in April 2008 - versus its derivatives traders asking the submitter for 1bp improvements and sometimes not even getting them.

**** Counterpoint: the Barclays traders themselves certainly assumed that other banks were doing the same thing.