Day of LIBOR Reckoning

Though collusion on rate executions
Was the norm in finance institutions,
When the tide quickly turned
Many bank traders learned
They would naturally face prosecutions.

The trouble with a culture of open financial fraud is that it leaves behind quite a paper trail in the unlikely eventuality that the authorities ever decide to crack down. So it is with the London Interbank Offer Rate-setting process, in regard to which US federal prosecutors and European regulators now intend to arrest individual traders on both sides of the Atlantic. Accounts differ as to how long the manipulation of LIBOR and related interest rates has gone on - some say 15 years - but central banking authorities in the US and UK have known of it since at least 2008. That was when staff members of the Federal Reserve Bank of New York discussed LIBOR with one or more traders who told them that their submitted rates were fake. Alarmed, then-FRBNY president Timothy Geithner sent off a "best practices" memo to Bank of England governor Sir Mervyn King, outlining ways to curb the abuses. Four years later, the media attention and public outcry have seemingly forced the hand of officialdom; against whom, we will soon hear.

From Geithner to King re: LIBOR

Some traders disclosed to the Fed
That LIBOR deceit was widespread;
The news reached Tim Geithner,
Who responded by writin' a
Quite well-stated memo, 'tis said.

In verbiage clear and concise,
Mr. Geithner dispensed his advice
To follow the fundin'
Of bankers in London
To find the most accurate price.

But the memo to King, while persuasive,
Is fairly alleged as evasive,
In its glaring exclusion
That traders' collusion
On setting of rates was pervasive.

Simon Johnson writes in his Baseline Scenario blog that the Federal Reserve Bank of New York may have missed an opportunity to inform its counterparts at the Bank of England of the LIBOR manipulation occurring back in 2008. Interbank traders active in the LIBOR-setting process had plainly admitted to the New York Fed that they gave self-servingly false indications of the rates at which their banks could fund themselves. Understandably concerned, the FRBNY's then-president Timothy Geithner spoke with the English central bank governor Sir Mervyn King, and followed up with a memo outlining his staff's recommendations for improving the LIBOR process. The memo, a model of brevity and clarity, outlines six proposals to improve the accuracy of LIBOR, which is based on funding rates reported by US and other international banks in the London market. Among the proposals: "Eliminate the incentive to misreport" by randomly selecting quotes from a subset of reporting banks.

What the memo did not mention was that the Fed already had admissions of fraudulent reporting from some of those banks. How might things have turned out differently if it had?