Wednesday, December 19, 2012

In 2008, Geithner was told about Libor manipulation

In a must read Financial Times article, then NY Fed President, Timothy Geithner was told in May 2008 about the manipulation of Libor.

His failure to take action highlights one of the major lessons of the financial crisis.  The lesson is the bank regulators' monopoly on all the useful, relevant information needed in an appropriate, timely manner to assess the risk of the banks must be ended as it creates instability in the financial system.

So long as the bank regulators have this information monopoly, the financial markets are dependent on the regulators to a) properly assess the risk of each bank and b) communicate this risk to the markets.

What we know for sure is that at times of financial stress, regulators will never communicate this risk to the markets for fear of undermining the stability of the financial system.

Imagine how different the entire Libor manipulation activity would have been had there been no regulator information monopoly and instead banks were required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With ultra transparency, banks would not have manipulated Libor as they would have been caught by market participants looking at the actual transactions for each bank.

With ultra transparency, regulators might not have been tempted to 'cover-up' the manipulation of Libor to make the banks look healthier than they actually were and still are.

By not requiring the banks to provide ultra transparency, we are now left with a situation where market participants have very good reasons to not trust the banks or their regulators.
The Federal Reserve Bank of New York was warned as early as mid-2008 that banks may have been misreporting their Libor borrowing rate to aid their own trading positions, much earlier than previously known. 
Tim Geithner, then president of the New York Fed and now US Treasury secretary, was told by a senior colleague in a May 2008 email of her concerns about banks’ deliberate misreporting. 
The email was part of an internal push among some at the New York Fed to press the Bank of England and the British Bankers' Association to reform the benchmark lending gauge, known as the London Interbank Offered Rate. 
It is the first indication that officials at the New York Fed had grown suspicious that banks may have been misreporting Libor to improve their trading results. Officials already had suspected banks were under-reporting their borrowing costs to mask the state of their financial health....
The email from Hayley Boesky to Mr Geithner – with three senior colleagues, Meg McConnell, Matthew Raskin and William Dudley, copied in – are among unreported emails seen by the FT that show New York Fed officials linking the incentive for banks to misreport borrowing rates to the bank’s derivatives positions....

“These individuals report to the head of [the] money markets desk, who often reports to the same person who oversees the derivatives book. They verify the posting with the boss to make sure it suits their derivatives position,” Ms Boesky wrote on May 23 2008....
The New York Fed documents played down the possibility of a link between alleged rate manipulation to traders’ derivatives positions. Rather, in those documents New York Fed officials linked Libor misreporting to banks’ fears of appearing financially weak. 
A global investigation spanning multiple continents now threatens as many as 20 banks and inter-broker dealers that may have been involved in manipulating interbank rates influencing hundreds of trillions of dollars’ worth of financial instruments from 2005 to 2009.
In an interesting post on NakedCapitalism, Yves Smith uses Mr. Geithner's failure to take action against the banks for manipulating Libor for profit to define the Geithner Doctrine:

which is “nothing must be done that will destablize the banking system.” 
However, Geithner also subscribes to the Humpty Dumpty School of Language, in which words mean what he chooses them to mean, nothing more or less. So “destabilize” means “hurts the profits or reputation of” and “banking system” means “any bank that is pretty big and/or well connected”.
Nothing must be done that will hurt the profits or reputation of any bank that is pretty big and/or well connected. 

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