Regular readers know neither the Fed nor the Bank of England covered itself in glory with its handling of Libor. This becomes more apparent as you read the 80 pages of emails the Bank of England just released showing its communications with the Fed and the British Bankers' Association (the bank lobbying organization that oversaw Libor).
Nowhere in the correspondence does the Fed tell the Bank of England that a Barclays' trader has said that Barclays is submitting manipulated rates.
On the other hand, on May 22, 2008 there is an internal Bank of England document that suggests the Bank of England has some idea that Libor was being manipulated.
There is a long standing perception that Libor by virtue of the manner in which it is set is open to distortions: panel banks have no obligations to trade or to have traded at the rates that they submit, so it is at least plausible that these are influenced by commercial incentives.The clear lesson to be learned here is that reliance on regulators puts the financial system at risk. To minimize regulatory risk requires that transparency be brought to all the opaque corners of the financial system.
For Libor, transparency means requiring the banks to disclose on an ongoing basis all of their current global asset, liability and off-balance sheet exposure details. This way, Libor can be based off of actual trades and the interbank lending market will be resistant to freezing as participants can evaluate the risk of each bank on an ongoing basis.
Well, did U.S. regulators sound the alarm on the Libor rate-setting scandal, or not? You sure can't tell from the conflicting stories this week by Bank of England Governor Mervyn King and U.S. Treasury Secretary Timothy Geithner.
Mr. King, who said he first learned of "fraudulent behavior" when the Barclays settlement was announced last month, told a British Parliamentary committee Tuesday: "At no stage did he [Mr. Geithner] or anyone else at the New York Fed raise any concerns with the Bank that they had seen any wrongdoing."....Your humble blogger previously pointed out this glaring omission. Mr. Geithner and the NY Fed did not tell the Bank of England and they did not tell the public in the run-up to the Dodd-Frank Act debate.
The latter is very important, because as shown by the Financial Times' Martin Wolf, who was a member of the Vickers Commission, transparency would have been included as a major element of reform had the Fed said it had confirmation that the Libor interest rates were manipulated.
Mr. Geithner and the rest of the Federal Reserve were so unalarmed about the claims of inaccurate Libor rates that they even continued to use Libor as a benchmark.
In September 2008, the New York Fed extended an $85 billion line of credit to rescue AIG. The interest rate for that loan was based on the three-month Libor rate, plus 8.5%. Two months later, the Fed restructured the rescue package, lowering the interest rate to Libor plus 3%....
All of this happened after the New York Fed had briefed the Treasury and regulators in Washington about reports it had received—often from the banks themselves—that banks were fudging their Libor submissions.
No wonder, as the Bank of England's number No. 2 Paul Tucker recently put it, "alarm bells" didn't go off....Actually, it is even worse as it calls into question the judgement of the Fed. What were they thinking to use a manipulated rate?
On the evidence currently available, Mr. Geithner and his fellow regulators were inclined at the time of the crisis in 2008 to treat understated Libor rates as a minor issue—a banking foot fault.
But now that the issue has stirred a political uproar and become a proxy for all banking sins, the regulators are joining the denunciations and descending from their parapets to shoot the wounded as if they had been on the front lines all along.