How Did They Pull It Off?

From the September 2012 Trumpet Print Edition

Since libor is the benchmark rate for $800 trillion worth of financial products, you would

think there would be a regulatory team keeping watch over how it was calculated. Or at least a couple of officials? How about at least one guy?

Nope. Not a soul. The libor rate is set by a club of “selfregulating” international banks. The same banks that brought us the subprime mortgage mess, the robo-signing/rocket-docket disgrace, Countrywide Financial and the Long Term Capital Management debacles, and generally every other major financial scandal of the last several hundred years.

To set the libor rate, 18 big banks simply quote the rate they think they would have to pay to borrow money. The British Bankers Association then throws out the four highest and four lowest rates reported, averages the rest and publishes the rate. No proof is necessary. The system operates on the honor code.

By throwing out the outliers, the theory was that no bank could manipulate the rates. Supposedly it was a foolproof system—but it wasn’t greed-proof. Wall Street’s finest found a way. It wasn’t difficult. Bank officials simply had to pick up the phone. Meet at the ninth hole at the country club. You can imagine the conversation.

Banker 1: “Hey guys, I have a large swap position that I am a bit underwater on; it would be helpful if interest rates drifted lower for a while.”

Banker 2: “Not a problem, buddy, just remember that in April rates need to be a point higher.”

Banker 3: “Why don’t you guys stop talking work and join us for a weekend on our private Cayman Island?”

Banker 4: “We can test-fly my new Gulfstream.”

And from the evidence released so far, it appears it was exactly these kinds of things that happened. $800 trillion in financial products moved by a conversation at a par 4.