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Freddie Mac Adorably Thought Banks Had Promised Not To Lie To It

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I guess we should talk about Freddie Mac suing all the banks for manipulating Libor. I know, one more Libor lawsuit, whatever. Barely even that: Freddie Mac was already suing all the banks for manipulating Libor, as part of various pending class action lawsuits; now it's just also suing them on its own.

So, why? If you compare the City of Baltimore class action lawsuit, which Freddie had joined, with Freddie's new lawsuit, one thing you might notice is that Freddie has eleven counts, while the class action only has two. More counts = more ways to win, sort of, I guess.

The class action makes pretty generic antitrust claims. Antitrust law is designed to (1) protect consumers from (2) evil cartels, so those claims require saying (1) we were Libor consumers and (2) you all banded together into an evil cartel to manipulate Libor, harming us as consumers. That's fine, and Freddie's new suit makes a similar claim. But it's tricky, because the claim "all you banks misstated Libor to hide your crappy financial condition from each other and cheat each other on derivatives trades" doesn't really sound like they were working together. More the opposite really. Even if all the banks were being manipulative crooks, that doesn't create antitrust liability unless they were working together to be manipulative crooks. And the evidence there is at least mixed.

So eight of Freddie's eleven counts are different and don't require any working together at all: they're just for breach of contract. Barclays and RBS and UBS and their less-admittedly-Libor-violating kin each had a contract with Freddie, and those contracts required them not to lie about Libor, and they lied about Libor, and so they breached their contracts.

So ... really? What contracts? This I think is a little clever: the answer is the ISDA Master Agreement, which Freddie had in place with each of its swaps counterparty banks1 and which could aggressively be read to contain language to the effect of "we won't lie about Libor." I mean, aggressively:

114. ... The Barclays Master Agreement further states that "[a]ll applicable information that is furnished in writing by or on behalf of [a party] to the other party [is] true, accurate and complete in every material respect." ¶ 3(d). The Barclays Master agreement requires that the parties comply in all material respects with all applicable laws and orders to which a party may be subject if failure to so comply would materially impair its ability to perform its obligations under the Barclays Master Agreement or any Credit Support Document to which it is a party. ¶ 4(c).

115. The Barclays Master Agreement provides that a party defaults any time that it makes or repeats a representation that proves to be incorrect or misleading in any material respect when made or repeated. ¶ 5(a)(iv)

That stuff in paragraph 115 is an amazing stretch - ¶ 5(a)(iv) of the Barclays Master Agreement, and of the other banks' ISDAs and for that matter of every ISDA Master, says that "A representation ... made or repeated ... by the party ... in this agreement" that turns out to have been false is an Event of Default; Barclays' Libor submissions aren't in the agreement.2 Barclays didn't sign an agreement with Freddie saying that it would never lie to anyone about anything, though in hindsight it would have been a hilarious oversight if it had.

Still, there's some vague appeal to this line of argument: we had a contract, that contract required you not to violate the law in a way that would impair your obligations under the agreement, you violated the law, the specific violation had something to do with your interest-rate swaps under this agreement, look over there a tiger, give us damages. Or: we had a contract, that contract required that all information furnished by or on behalf of you be true, and the British Bankers' Association furnished Libor to, um, everyone, including us, on your behalf, sort of, I dunno, damages.

It's pretty hazy, but if Freddie gets any traction you can imagine other contract counterparties following their lead. Start with municipalities (or for that matter corporates and smaller banks) that did swaps with the Libor-panel banks and presumably also have generic ISDA Masters with the same terms. Add ... I dunno, I'm sure lots of contracts have words that could be read broadly as "we are not lying to you." Not, perhaps, adjustable rate mortgage notes, but then the theory for suing Libor banks over those was always a little far-fetched.

Anyway, there are eight counts like this, one for each of BofA, Barclays, Citi, CS, DB, HSBC, RBS, and UBS. After saying what the ISDA Master said, Freddie goes on to say "During the relevant period, Freddie Mac entered into more than 100 pay-fixed swaps governed by the Barclays Master Agreement," etc., on all of which I guess they were victims of Libor manipulation. All in all I count at least 1,260 pay-fixed swaps (more than 300 of them with Deutsche Bank) betweeen August 2007 and May 2010.

That is a lot of times to be deceived by Libor! Especially when everyone knew that Libor was being manipulated at the time: the Wall Street Journal reported on it in April 2008, and in September 2007 Barclays was sending out client updates saying "libors are again becoming rather unrealistic and do not reflect the true cost of borrowing." "Everyone knew" is always an exaggeration - sure, mortgage borrowers and municipal swap customers probably weren't up on the latest gossip in the rates market - but, y'know, the guy at Freddie Mac who signed twelve hundred swap confirmations? What was he doing when he wasn't signing confirmations?

Also: the problem with Libor was that it didn't reflect the actual cost of banks' short-term funding. You know who might be in a good position to notice that? A company that provided billions of dollars of short-term funding to banks. Like say Freddie Mac:

During 2008, we increased the balance of our cash and other investments portfolio by $14.0 billion, primarily due to a $36.8 billion increase in highly liquid shorter-term cash and cash equivalent assets, including deposits in financial institutions and commercial paper ...3

Freddie is kind of arguing that the banks were lying to Freddie about the rate they were paying Freddie to borrow from Freddie. Maybe true! Still, if Freddie and Fannie did in fact lose $3 billion that way, it's not exactly impressive stewardship of shareholder (taxpayer, what-have-you) money.

Freddie Mac Sues Multiple Banks Over Libor Manipulation [Bloomberg]
Freddie sues over ‘substantial’ Libor loss [FT]
Federal Home Loan Mortgage Corp. v. a whole bunch of banks [E.D. Va.]

1.And which it filed, which was a nice touch. Here's RBS, here's Barclays, here's UBS. These are mostly generic ISDA Masters - the RBS one, the most recent, seems to lack any schedules at all - and they didn't file the credit support annexes, which are where the fun stuff goes.

2.Freddie goes on to say that "The Barclays Master Agreement states that ... [it] and all confirmations form a single agreement between the parties. ¶ 1(c). A 'confirmation' is defined in the first paragraph as the documents and other confirming evidence exchanged between the parties for each transaction." Were Libor rates part of that "confirming evidence"? Is quoting a true Libor rate based on false Libor submissions a misrepresentation? Meh.

3.It goes on "As a result of counterparty credit concerns during the latter half of 2008, these deposits in financial institutions included substantial cash balances in accounts that did not earn interest," which sounds pretty counterintuitive until you remember that in 2008 the FDIC "provide[d] unlimited deposit insurance coverage for noninterest-bearing transaction accounts."