Barclays Libor Settlement: Emails Reveal Bank Catered To Traders' Demands


When will bankers learn to stop sending each other dumb emails?

The Barclays settlement on Wednesday of accusations it manipulated a key interest rate involves many, many incriminating emails suggesting the bank catered to its traders' needs, to the point that it ran afoul of regulations.

But first, a little bit of set-up is in order to understand just how dumb these emails were.

Barclays was charged with manipulating something called Libor, which sounds like an animal Napoleon Dynamite invented. What the heck is a Libor, you ask? Also, who cares? Both questions are easy to answer.

Short answer to the second question: This is probably just one of many banks that have been monkeying around with a market that affects borrowing costs on both sides of the Atlantic, deceiving market watchers and regulators and lining their own pockets.

The less-short story is that Barclays has agreed to pay a whopping $450 million to settle charges it manipulated "Libor," which is short for the "London interbank offered rate." This is a short-term interest rate that is used to help set the rates for all sorts of borrowing, from corporate bonds to personal loans and adjustable mortgages.

So that right there tells you one direct real-world impact of not having proper Libor rates -- borrowing costs might be too high or too low for businesses and people. Not good.

But that particular impact is very difficult to quantify, and I'll bet it's not really too significant. In many cases Barclays and other banks have been accused of setting Libor too low -- which is not going to get a lot of complaints from borrowers.

One maybe more important, and reputationally damaging, impact is that Barclays and other banks have pushed Libor too low to make themselves look better to investors. This was especially a problem during the financial crisis, as Carrick Mollenkamp and others at the Wall Street Journal reported extensively (Mollenkamp is now with Reuters).

The way Libor works is a group of banks report what they're being charged to borrow at short terms, and then those reports are used to set Libor every day. The giant flaw in this system is that banks often have an incentive to mis-report what their borrowing costs really are, which makes a mess of Libor.

During the crisis, banks were terrified of lending to each other, so Libor rates should have reflected that by rising -- after all, when you're anxious about lending money to somebody, you usually charge them higher interest rates, no? But that really didn't happen during the crisis, which made regulators very suspicious. Maybe banks were not being quite so honest about their borrowing costs.

We'll give you a moment to process the idea that banks might not always be fully honest.

OK, so now to the emails:

Banks have another incentive to skew Libor -- their trading desks. Libor affects about $350 trillion worth of derivatives contracts, which is kind of a lot of money, when you think about it. So there's a lot of money to be made in those contracts, and it's a lot easier to make that money if you know what Libor is going to be on any given day.

So, as described in juicy detail in the CFTC's order in the Barclays case, traders routinely pushed their colleagues in charge of submitting Libor quotes to move Libor up or down as their trading needs dictated.

In theory, there's a "Chinese wall" between trading desks and a bank's Libor gnomes that keeps this sort of thing from happening. But it appears Barclays traders poked holes in that Chinese wall, then knocked it down, set it on fire, roasted marshmallows over it and made s'mores with the marshmallows.

Here's just a sampling of the many trader emails found in the CFTC order:

"Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the libor fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot." (September 13, 2006, Senior Trader in New
York to Submitter)

"For Monday we are very long 3m cash here in NY and would like the setting to be set as low as possible ... thanks" (December 14, 2006, Trader in New York to Submitter)

And the submitters were kind of embarrassingly eager to help! More emails:

"Always happy to help, leave it with me, Sir." (March 20,2006, Submitter's response to a request)

"Done ... for you big boy ... " (April 7, 2006, Submitter's response to swaps trader requests for low one-month and three-month U.S. Dollar LIBOR)

"It's pretty amazing," CFTC Commissioner (and "Die Hard" villain, am I right?) Bart Chilton told CNBC. "The traders were barking orders to the submitters like they were at a fast food restaurant. You know, 'I'll have a Number Five.'"

Barclays was just one of many banks who have been under investigation for manipulating Libor -- this settlement could be just the first shoe to drop in a big mess of trouble for banks on both sides of the pond.

And something tells me there will be emails involved.

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