By Johanna Treeck, Geoffrey Smith
What is the scandal about?
A new book alleges that the traders who went to jail after the global financial crisis for conspiring to rig benchmark interest rates were victims of a miscarriage of justice. Author Andrew Verity makes the allegation that the traders were under duress from state agencies — governments and central banks — to provide fake reference rates that would ease the sense of panic that gripped the world in the late summer of 2008.
The allegations are important because, if true, they would show that authorities made relatively junior bankers suffer for offenses that they themselves were ultimately responsible for.
What are Libor and Euribor and why do they matter?
Libor and Euribor are interest rates that reflect the price at which banks lend to each other, one fixed in London, the other in continental Europe. The rates are important for consumers and businesses everywhere as they act as the benchmark reference rate for trillions of dollars’ and euros’ worth of debt instruments, including government and corporate bonds and mortgages.
Euribor is the Euro InterBank Offered Rate, Libor the London InterBank Offered Rate. They used to be calculated freely by their respective panels based on banks’ assessments. Evidence of manipulation led the authorities to impose new calculation methods, which are now based on actual transactions rather than subjective judgments meaning the market is in the process of phasing out both Libor and Euribor.
Who was on the line?
Andrew Verity’s book, ‘Rigged’, excerpts of which are being serialized in The Times, carries the stories of traders who were convicted and jailed for rigging the benchmark rates. While the account of Barclays coming under pressure from the Bank of England is already familiar, Verity also alleges there was similar pressure from the Eurosystem — which comprises the ECB and the region’s national central banks — on banks to create an equally false impression of stability in the eurozone on the eve of the 2008 crisis. He writes that “Barclays’ Mark Dearlove and Jon Stone, the bank’s group treasurer, told the Bank of England on November 4, 2008, they thought there had been political pressure on French banks to cut their contributions to Euribor, the equivalent of Libor for euros.”
The ECB at the time was led by Frenchman Jean-Claude Trichet who had previously served for 10 years as chief of the French central bank. Trichet’s successor at the Bank of France was Christian Noyer, who had previously been vice-president of the ECB.
The Bank of England | Neil Hall/EPA-EFE
What does the data show?
According to the report, French banks had “suddenly, as one, dropped their submissions of their estimates of the cost of borrowing euros in the days that followed a coordinated central bank interest rate cut on October 8, 2008.” The scale of the drop — around 0.4 percentage point — was bigger than any previous movement and could not be explained by market factors, it argued.
POLITICO asked the opinion of an independent expert who has in the past provided witness testimony in interest-rate manipulation cases and who was granted anonymity to maintain trust with market sources. He noted individual banks’ submissions between October 8-15 seemed highly unusual and not what would ordinarily be expected. Banks that the market would have expected to be most exposed to Lehman Brothers ― the investment bank that collapsed less than a month earlier ― lowered their submissions the most. Also, while the ECB announced it would institute a new way of operating as of October 15, promising to meet all the cash demands of banks at a fixed rate, the facility was dependent on banks having enough eligible collateral and provided only one week’s worth of funds.
Wait, what? I thought central banks set interest rates?
Central banks vary across the world in how they influence interest rates. But while they all set the rate at which their own funds are renumerated or lent within their own networks, they can’t always control how their rates impact the wider market. To influence rates more broadly, and to make sure the so-called “transmission mechanism” is working, central banks sometimes engage in what are known as “open market operations”. These operations are usually conducted by central banks’ market trading desks and involve buying and selling or lending and borrowing securities in the market directly. The challenge for central banks with Libor and Euribor was that both of these rates represented an unsecured cost of financing between banks, which couldn’t be as easily influenced by these sorts of operations. The rates were by design supposed to reflect the cost of borrowing from other banks so that banks could avoid borrowing from the central bank.
How badly did they want to lower Euribor? Why did they even want to?
Very badly. There is no doubt about that — even if it has yet to be established how far they were ready to go. The timing is important: less than a month after the collapse of Lehman, there was widespread fear of a domino effect that could have created a depression to rival that of the 1930s. The authorities were desperate to avoid another disorderly bank failure and were acutely aware of how ill-prepared both they themselves and the banks were for the unfolding crisis.
When the ECB cut its rates again in November 2008, Trichet sent a stark message to banks at the ensuing press conference: “We encourage the commercial banks very strongly, through all channels, to take fully into account all the decisions that have been made.” While acknowledging that “we are in market economies” and decisions should be taken individually by banks, Trichet asked them “on behalf of the Governing Council, to be fully up to their own responsibility in the present circumstances.”
When you say ‘all channels’…?
Yes, well, that’s the question, isn’t it? Trichet’s public call on the banks to exercise social responsibility is not the best example of the free market red-in-tooth-and-claw doing its Darwinistic thing, but no court in Europe would convict him of exerting undue pressure on banks on the basis of those words alone. The issue is more whether there were other private channels where more forceful means of persuasion might have been used. If that were the case, then traders who were prosecuted and imprisoned would have a strong argument they had suffered rough justice and a case for redress.
What do the authorities say?
The European Central Bank vehemently denies that “all channels” could also imply direct calls to banks exerting pressure.
“The European Central Bank strongly rebuts the assertions made by the BBC, which misrepresent the role of a central bank in implementing monetary policy,” the ECB said. “The ECB has always acted in line with its mandate and in full compliance with the law applicable to it.”
The Bank of France, for its part, didn’t want to comment on the reports, while Trichet didn’t respond to a request for comment in an email sent to his Bank of France address. Noyer was approached for comment but had not replied at the time of publication.
What now?
Central banks will remain on tenterhooks as instalments of the book are released. Even if not enough evidence emerges to warrant an official investigation, it risks further damaging the reputation of institutions on both sides of the Channel that are battling to tame the biggest cost-of-living crisis in half a century.
Izabella Kaminska contributed reporting.
