Libor Scandal Update: More Evidence From Mid-1990s

Larry Doyle
updated | Author's Website

Headlines this morning highlight the fact that SAC’s “portfolio manager A”, aka Steven A. Cohen, is linked to the largest insider trading scandal brought to date by the US Attorney’s Office in New York.

This $276 million scandal and the fact that Stevie-boy might finally be hooked is sure to create ooh’s and aah’s across Wall Street and the nation. If proven, Cohen and other conspirators deserve what they get in terms of hard time.

Meanwhile in the adult pool little attention is paid to the fact that the “institutional” Libor manipulation scandal had bombshell developments yesterday. Let’s navigate.

I maintain that the Libor manipulation scandal is the single greatest financial fraud in our history. Wall Street firms would clearly like to ring fence this scandal to a handful of rogue traders going back only 5 years or so. In the process, senior managers and those even higher up in a whole host of banks can be protected. Classic Mob-style tactics of creating the wall of protection. Not so fast.

A few months back I highlighted the story of a trader at Morgan Stanley named Doug Keenan who indicated that Libor was being manipulated back in 1991. Now we learn that others warned of the potential likely manipulation of this most widely tracked overnight interest rate back in the mid-1990s. Reuters provides riveting details in writing,  Special Report : How Gaming Libor Became Business as Usual,

In late 1996, Marcy Engel, then a lawyer for Wall Street heavyweight Salomon Brothers Inc, fired off a warning letter to U.S. regulators: If they approved a Chicago Mercantile Exchange plan to change how a popular futures contract was priced, they would put at risk the integrity of a key interest rate in the global financial system.

The CME was already doing big business in its Eurodollar futures contract – a derivative product that lets traders bet on the direction of short-term interest rates – and it had long set the price for these contracts using a benchmark rate it tabulated itself. Now, it wanted to adopt a more commonly used rate published by the British Bankers’ Association, known as the London interbank offered rate, or Libor. Using this benchmark, the CME said at the time, “will make our Eurodollar futures an even more attractive risk management tool.”

The problem with the CME’s plan, as Engel saw it: The banks that set the rates in London daily were also able to take positions in the CME’s Eurodollar contract. In her letter to the U.S. Commodity Futures Trading Commission, she said tethering the futures contract to Libor “might provide an opportunity for manipulation” of the interest rate. A “bank might be tempted to adjust its bids and offers … to benefit its own positions.”

That was saying a lot. Libor is the average of what a group of international banks in London say it costs to borrow from each other for durations ranging from overnight to one year. It was, and still is, a global benchmark, the basis for all sorts of interest rates – everything from corporate and student loans to financial contracts. Moving it by mere fractions of a percentage point would affect borrowing costs around the world.

The CFTC received Engel’s letter on October 10. In the ensuing weeks, it received one other similar written warning from another banker. The agency wasn’t moved. In late December, it approved the CME’s request. On January 13, 1997, trading of Eurodollar contracts priced to Libor began.

The CME was right about the allure of pricing the contract to Libor. Trading of the Eurodollar contract exploded after the switch – from average daily volume of 394,348 contracts in 1997 to a peak of 2.5 million in 2007. Today, the trading accounts for about 7% of revenue for CME Group Inc.

But Engel was right, too. Since 2008, investigators in the United States, Britain and elsewhere have been looking into whether at least some of the 19 banks that take part in the weekday ritual of setting Libor used their place at the table to try to routinely nudge the rate in their favor.

The investigations cover the period from 2005 to 2009. But as Engel’s letter – obtained from CFTC archives – shows, regulators were alerted to the possibility well before U.S. and British authorities began investigating the matter in 2008. Further, a review of investigation documents and public records, as well as interviews with dozens of traders, suggests that Libor manipulation began as early as the 1990s, driven in large part by the growth of the CME’s Eurodollar contract into a multi-billion-dollar casino for betting on interest rates. (LD’s highlight)

Indeed, by the mid-2000s, manipulating Libor to profit on Eurodollar futures and other derivatives had become standard operating procedure among banks in a position to do so, according to people familiar with the market.

$276 million is a BIG number. Steven A. Cohen is a BIG name. That said, that number and that name pale in comparison to the multiple billions of dollars and the senior management on Wall Street (and regulators in Washington) involved in the manipulation of Libor over the course of the last 15 to 20 years, folks!!

Will the truth of this scandal ever fully come out? Will those involved even at the senior most levels of these banks receive real justice?

Little wonder why investors are fleeing our markets in droves (see declining volumes across almost every market segment and accompanying continued layoffs on Wall Street) and have little confidence in our regulators.

Navigate accordingly.

Related Sense on Cents Commentary
Sense on Cents/Libor Scandal

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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