Libor: Who lost out when the rate was fixed?
The furore triggered by the revelation that Barclays fiddled Libor has focused on one question - who was responsible? But two other questions are also worth asking.
Is it possible for one bank to move the Libor number on its own?
And how much damage did messing with Libor actually do? After all, most financial bets are two-way - for every winner, there is a loser.
Let's remind ourselves of the basics:
- Libor is the London Interbank Offered Rate
- It is the figure - actually there are many of them, in different currencies and for short, medium and long-term loans - intended to summarise how much interest banks have to pay when they borrow money from other banks
- A large slice of the global trade in financial derivatives - hundreds of trillions of dollars worth of transactions - relies on Libor as a benchmark
In 2008, we visited the Thomson Reuters offices where Libor is calculated. We were the first journalists to do so.
At the time, when the world was still reeling from the collapse of Lehman Brothers, Libor was the most closely-watched number on the planet - because it indicated just how much trouble the banking system was in.
The Libor people talked a lot about the resilience of their system. But for all that, the way Libor numbers are calculated is simple.
At 11:00, banks call the Libor office to report how much interest they would have to pay if they were to borrow money that morning. It's hypothetical. You don't actually have to borrow money. You're reporting what those loans would cost if you if you did.
All those reported interest rates are then averaged, but - and this is important - the top and bottom quarters are excluded. The Libor people do that to prevent any one bank from having a disproportionate impact on the final Libor number.
But it is still possible for one bank to move the rate, even if that bank's Libor number is in the top or bottom quarter, and so excluded from the calculation.
Here's why. Imagine there are four banks. Bank One quotes 1%. Bank Two quotes 2%. Bank Three quotes 3%. And Bank Four quotes 4%. Now the top and bottom quotes will both be discarded. Libor will be the average of 2% and 3% - in other words, 2.5%.
Now let's say Bank One wants to raise Libor. Instead of quoting 1%, it quotes 5%. Assume all the other banks quote the same as before. Bank One's quote will be discarded again. But by moving from the lowest quote to the highest quote, Bank One influences which other quotes will count. Libor will be the average of 3% and 4% - in other words, 3.5%.
In reality the effect will be small, measured in "basis points" - which are 100th of a percentage point. But with enough cash on the line, it's enough for a trader to make money.
"Up until the financial crisis," says Jonathan Rosenthal, banking editor of The Economist, "Libor actually moved in a really narrow range. So it would have been quite difficult to move Libor by very much… a basis point or so, or even less."
But during the financial crisis, many observers concluded that Libor had become detached from reality, because banks didn't want to admit that they were having trouble borrowing money.
"Where it becomes slightly more complex," says Rosenthal, "is we do know that there were at least attempts by banks, or traders at banks, to act together. Once you have a few banks acting in concert then the potential to move Libor by larger amounts is possible."
The first bout of Libor fixing was a bit like fixing a spot bet on a sporting match - that a football match would have a certain number of throw-ins, for example. It's dishonest, and leaves a bad taste in the mouth, but it usually won't affect the broader outcome much.
The second bout during the financial crisis, when some banks tried to act in concert, was more like turning a real sport into a choreographed spectacle such as professional wrestling.
So who might actually have lost as a result of the Libor manipulation? "The potential pool of losers is vast," says Lianne Craig, a partner in the law firm Hausfeld and Co LLP. "Pension funds, insurance companies, note-holders, entities and individuals."
If your mortgage or car-loan was pinned to Libor then perhaps you were disadvantaged by the manipulation of the rate. But it is also possible that you benefited from it.
A significant number of US mortgages, for example, are explicitly pegged to Libor. If Libor was artificially suppressed for a period, payments on those mortgages may have been lower during that period than they should have been. Then again, over the same period, it's possible that those mortgage-holders' pension funds were losing out on interest as a result of the low Libor number.
Some large organisations, however, might be able to prove that they lost significant sums.
Hausfeld's US sister company is taking a leading role in a class action lawsuit against the banks on behalf of, among others, the City of Baltimore, which - Craig says - was a very big loser.
"Essentially the city of Baltimore was on the wrong side of hundreds of millions of dollars of interest rate swaps so has potentially suffered astronomical losses."
Of course, law firms like Hausfeld have an interest in arguing that their clients lost money. Proving it will be complicated.
"We are just beginning to look at possibilities with market experts and economists," says Craig. "But in essence what we would anticipate doing, would be to look at a counterfactual. So what would have been happening had Libor not been manipulated."
Proving a counterfactual is not easy, and we can expect the legal side of the Libor scandal to play out over a very long period, and all over the world.
While many Libor losers are likely to try to sue the guilty banks, people who profited from the manipulation of the rate - and most who did will have done so unknowingly - will not be expecting to return the money.