If you think fixing boxing matches is bad, this one will blow you away. Over the past decade, major banks have been submitting false data to the London Interbank Offered Rate (LIBOR) in order to manipulate it and make huge profits. UBS, which is the largest bank in Switzerland, agreed to pay $1.5 billion in fines to international regulators for their role in the LIBOR scandal. By the way, UBS is on the list of the 29 “global systemically important banks.” It’s too big to fail.

That’s just the tip of the ice berg. Then President of the New York Federal Reserve Tim Geithner was warned as early as mid-2008 that banks may have been deliberately misreporting their LIBOR borrowing rate in order to aid their own positions. In July 2012, the New York Fed released documents dating back to 2007 which showed that they were aware that banks might be lying when setting LIBOR. The Fed proceeded to press for reforms, quietly so as to not disrupt a feeble financial market in the midst of the global recession. In 2008, they even held a “Fixing LIBOR” meeting with at least eight senior Fed staffers invited.

The way LIBOR works is that it is an average of interest rates submitted by major banks in London. This serves as a benchmark for global interest rates. It is supposed to reflect the health of the financial market, and many investment portfolios have a link to it. So when banks colluded and submitted false data in order to manipulate it, the people “in the know” were able to invest accordingly.

In all of this, who got the short end of the stick? Fannie May and Freddie Mac for one. They lost more than $3 billion because of the manipulation. Many U.S. municipalities also lost billions. LIBOR impacts rates on everything from municipal bonds, to derivatives, to adjustable rates, to credit card interest rates and more. They even found that LIBOR was being manipulated at the beginning of every month in order to increase the cost of refinancing a home.

As a result of this global racketeering, on September 25, 2012, the British Bankers’ Association said that it would transfer oversight of LIBOR to U.K. regulators. Yes, before that the banks were in charge of making sure the banks submitted correct data. The framework of the new system of oversight was laid out in the Wheatley Review, adopted by the U.K. There will be a new independent administration entity, oversight committee, and criminal offenses for market abuse. Transaction data will be explicitly used to support LIBOR submissions. Hopefully the reforms will prevent this from happening again. However, the whole debacle has shined a light on the problems of regulating a global financial system. Protections in one country cannot prevent a breakdown in another, which affects the whole system.

Additional Resources

Time, UBS to Pay $1.5 Billion Over LIBOR Scandal: http://business.time.com/2012/12/19/ubs-to-pay-1-5-billion-over-libor-scandal/

The Huffington Post, Federal Reserve of New York Proposed Reforms for Libor Issues in 2007-2008: http://www.huffingtonpost.com/2012/07/10/federal-reserve-of-new-york-libor-scandal_n_1661268.html

The Wheatley Review of LIBOR: http://cdn.hm-treasury.gov.uk/wheatley_review_libor_finalreport_280912.pdf

Time, LIBOR Scandal: http://business.time.com/2012/12/20/libor-scandal-yep-its-as-bad-as-we-thought/

The Wall Street Journal, U.S. Charges Star Trader: http://online.wsj.com/article/SB10001424127887324731304578189752666144398.html?mod=WSJ_World_LEFTSecondNews

Bloomberg, Fannie Mae, Freddie Mac Libor Loss Tops $3 Billion in Audit: http://www.bloomberg.com/news/2012-12-19/fannie-mae-freddie-mac-libor-loss-tops-3-billion-auditor-says.html