The Cartel: Behind the Scenes in the Libor Interest Rate Scandal
There have been plenty of banking scandals, but none quite like this: Investigators and political leaders believe that the manipulation of the Libor benchmark interest rate was the result of organized fraud. Institutions that participated could face billions in fines and penalties. By SPIEGEL Staff
Eduard Pomeranz and Rolf Majcen are small fish in the shark tank of international high finance. Their hedge fund, FTC Capital, is headquartered in tranquil Vienna and manages only 150 million ($189 million) in assets. But now Pomeranz, the founder, and Majcen, the head of the legal department, have been able to strike fear in the hearts of the big fish.
"The Libor manipulation is presumably the biggest financial scandal ever," says Majcen, a man with slightly disheveled-looking hair and Viennese sarcasm. Yes, he says, it did shock him that something like this was even possible, namely that a group of international banks had been manipulating interest rates for years. But Majcen takes a matter-of-fact approach to it all. As a financial professional, he is only one of many who want to get back the money that they feel they've been cheated out of.
At the end of June, British and American regulators imposed a $500 million fine on Barclays, the major British bank, and forced its CEO Bob Diamond to resign. Since then, a war of sorts has erupted in the financial sector. Investigators are attacking presumed offenders, banks that are involved are denouncing others in the hope of mitigating their own penalties, and small investors like Majcen are inundating Libor banks with lawsuits.
Deutsche Bank and more than a dozen other financial giants have come under sharp criticism due to the alleged manipulation of the Libor ( London Interbank Offered Rate), a benchmark interest rate. Some are even referring to the banks that are instrumental in calculating that rate a cartel, the sort of vocabulary not normally associated with the financial industry.
Regulators are using terms like "organized fraud." European Justice Commissioner Viviane Reding has suggested that bankers ought to be called "banksters." But in the case of some agencies, especially in New York and London, the outcry is also convenient; it diverts attention away from their own failures. For years, regulators overlooked what was happening right in front of their eyes.
Now that the authorities have woken up, they are aggressively pursuing the offenders -- and are reaching all the way up to the boardrooms. More than half a dozen government agencies, from Canada to Japan, are investigating the case.
German authorities are also involved. A dozen employees of Germany's central bank, the Bundesbank, have paid several visits to Deutsche Bank in recent weeks. They work for BaFin, the German federal financial supervisory authority, which has ordered a special audit, and are poking around the bank's headquarters in Frankfurt, traveling to London, where its money market traders are based, and flying to Tokyo. Even the bank's two new co-CEOs, Anshu Jain and Jürgen Fitschen, are expected to sit down for a question and answer session with the auditors. This is particularly unpleasant for Jain, who, as head of the investment banking division during the period in question, was ultimately responsible for money market transactions.
Libor, Anchor of the Financial World
The Libor and Euribor (Euro Interbank Offered Rate) are used worldwide as the benchmark rates for financial transactions worth hundreds of trillions of euros. When a savings bank issues a loan to a business at a variable interest rate, the loan agreement is based on the Euribor. "In many cases, the Euribor is even the key guideline for the structuring of call money," says Falko Fecht, a professor at the Frankfurt School of Finance, referring to overnight and other such short-term loans. In Spain, in particular, tens of thousands of construction loans are based on the Euribor, while millions of mortgage loans in the United States are pegged to the Libor rate.
But the bankers in the cartel initially had their sights set on a completely different business. They wanted to influence the giant market for interest rate and foreign currency derivatives in their favor. The volume of outstanding transactions in this area amounted to 567 trillion at the end of 2011 alone. Changes of as little as 0.01 percentage points can translate into hundreds of millions in profit or loss for some banks. This makes the lax approach to the calculation of rates taken for years by banks and regulators alike seem all the more astonishing.
A total of no more than 18 banks, including Deutsche Bank, are involved in the calculation of the Libor. Every morning, they submit estimates of the costs at which they believe they could borrow money on the markets without collateral. Using the resulting data, financial services provider Thomson Reuters calculates averages -- for 10 different currencies and 15 different borrowing periods.
A similar method is used to calculate the Euribor, except that there significantly more banks -- 43 -- involved in the process.
Nevertheless, it is hardly a rigorous calculation. The averages are based on rule-of-thumb estimates; the market supposedly reflected in the data sent to Thomson Reuters has been dead since the financial crisis. Only very few banks can borrow money today without furnishing collateral.
Furthermore, neither bank executives nor regulators have shown much interest in how the important benchmark rate is determined. Inputting the data was often left to ordinary money market traders, who had serious conflicts of interest and acquired a dangerous amount of influence on the financial world. "The Libor interest rate was practically an invitation to manipulate," says BaFin head Elke König.
The Cartel Emerges
In 2005, a young trader with Moroccan roots came to Barclays: Philippe Moryoussef, who is now 44. For him, it was only one station of many: Société Générale, Barclays, Royal Bank of Scotland, Morgan Stanley and, finally, Nomura. The Japanese had let him go when it became clear what role Moryoussef allegedly played in the interest-rate cartel.
In the London financial district, Moryoussef was seen as cool and unassuming. He liked diving, read books and didn't put on airs in public, even when he moved into a £2.5-million ($3.9 million) apartment in London's St. John's Wood neighborhood with his wife and two children.
Moryoussef traded in interest rate derivatives during his time at Barclays. He and his fellow traders knew exactly how much money they stood to lose or gain if the Libor or Euribor changed by only a fraction of a percentage point in one direction or the other.
And they apparently did everything they could to eliminate happenstance. Moryoussef communicated by phone or email with colleagues inside and outside the bank almost daily to steer interest rates in the right direction. To do so, they sent inquiries to the people who were responsible for inputting the Libor rates: the money market traders.
In the glitzy world of investment banking, money market traders were at the bottom of the pecking order before the financial crisis. They were not involved in major deals, and they could only dream of the kinds of bonuses stock and bond traders received. "They were always at the bottom of the food chain," says a former investment banker.
It was a conspiratorial group of underdogs who worked for various banks and met at least once a month for a beer or a mojito in New York, London or Frankfurt. By the middle of the last decade, when there seemed to be a surplus of money at the banks, they all had the same problem: They were derided or, worse yet, ignored by their colleagues in the trading rooms of major banks.
But what if it were possible to know where interest rates were headed at the end of the day, or even in the next hour? What if a few traders could manipulate the ups and downs of interest rates?
By 2005 at the latest, the traders would seem to have begun realizing just how much power they had were they able to collaborate within their small group. There was no need for formal contracts between large institutions, merely agreements among friends. A pointer here, a few traders meeting for lunch there, and soon the group had formed a global cartel that, according to investigators, reached from Japan to Europe to Canada.
"Come on over; I'll open a bottle of Bollinger," a trader, inebriated with his success, wrote to a colleague after the Libor rate had been set. Adair Turner of the British regulatory agency quotes the email as evidence of "a culture of cynical greed in the trading rooms."
The Organized Fraud
"If the rate remains unchanged, I'm a dead man," a trader emailed to a colleague who was responsible for Libor in October 2006. The traders sent at least 173 inquiries of this nature between 2005 and May 2009 for the dollar Libor alone. They were often successful.
Moryoussef, listed in the files of Britain's Financial Services Authority (FSA) as "Trader E," specialized in the Euribor. He reportedly bet 30 billion on certain movements of the interest rate, a normal dimension in the fast-paced money market. "The trick is that you can't do it alone," he bragged to outside colleagues at HSBC, Société Générale and Deutsche Bank, who allegedly cooperated with him.
While the traders were initially out to increase their bonuses, the manipulation took on a different dimension during the crisis. When the first banks began to wobble in 2007, it became more difficult for many financial companies to borrow money -- a problem that would normally be reflected in higher Libor rates.
Now even top managers at Barclays, alarmed by media reports, were instructing the Libor men to input lower rates. In October 2008, the manipulation became a question of survival for Barclays. On Oct. 29, a concerned Paul Tucker, now the deputy governor of the Bank of England, contacted Barclays CEO Diamond. Tucker wanted to know why the bank was consistently inputting such high interest rates into the daily Libor report.
Diamond told a parliamentary committee that Tucker had seemed to imply that lower interest rates be reported for the Libor, which Tucker staunchly denies. Diamond, for his part, prepared a transcript of the telephone conversation he had had with Tucker on that day, in which he had mentioned political pressure. After that, his chief operating officer spoke with the money market traders. The underdogs were suddenly being heard on the executive board, and had become the bank's potential saviors.
Barclays wasn't the only bank that was having trouble gaining access to money in the fall of 2008. UBS, Citigroup and the Royal Bank of Scotland, now prime suspects in addition to Barclays, had to be bailed out by their respective governments. Germany's WestLB, which was involved in the Libor calculation at the time, was also seen as a problem case, although this wasn't reflected in the Libor rates it was reporting.
As early as the fall of 2011, Deutsche Bank's chief risk officer at the time, Hugo Bänziger, ordered an internal audit. Millions of emails had to be reviewed and chat minutes read. Bänziger hired an outside auditing firm, and soon there were 50 people on the team responsible for the scandal. But it was a deeply frustrating task for the auditors; they didn't even know where to begin.
Only when British investigators released the names of two suspicious traders was the audit team able to report success to then CEO Josef Ackermann. Seemingly sensing what was in store for his bank, he inquired about the progress of the audit on a weekly basis. Two traders were fired.
Since the departures of Ackermann, Bänziger and former Supervisory Board Chairman Clemens Börsig, Börsig's successor Paul Achleitner has managed the bank's handling of the Libor scandal. He is reportedly firmly convinced that the bank never tried to push down the Libor to improve its own position. Financing problems? Not at Deutsche Bank, says Achleitner. He also notes that there are no indications that executive board members, or even Anshu Jain, were directly involved in the scandal.
But is it possible that only two wayward traders took part in the cartel? Why were no supervisors and no compliance officers aware of their activities? Deutsche Bank prides itself on being a world leader in the trade in foreign currencies and interest rates. It is part of all panels involved in determining the Libor. And yet Deutsche Bank merely sees itself as a bit player in the Libor-fixing scandal.
But why then was Alan Cloete, thought to have been responsible for the money market business and other areas during the wild Libor years, unaware of the manipulation? And why did Jain promote the stocky South African to the expanded executive board in March, while the investigations and internal audits in the Libor matter were already underway? There are those associated with the bank who think this is odd, while others see it as proof that Cloete is blameless in the Libor case.
The Failure of the Regulators
On April 11, 2008, a member of the Barclays money market team called Fabiola Ravazzolo, an employee of the Federal Reserve Bank of New York.
Barclays employee: "LIBORs do not reflect where the market is trading, which is, you know, the same as a lot of other people have said."
Ravazzolo: "Mm hmm."
A few moments later, the Barclays man, according to the transcript of the conversation released by the bank, said: "We're not posting, um, an honest Libor."
Barclays-Mann: "We are doing it, because, um, if we didn't do it it draws, um, unwanted attention on ourselves."
There was no sense of outrage, nor did Ravazzolo question the Barclays employee about the details. A similar conversation transpired with another Fed employee a few months later.
These are transcripts of failure. Barclays employees also contacted British regulators 13 times to report possible misconduct among the competition in determining the Libor, FSA chief Adair Turner admitted in a hearing before the British investigative committee. No one sounded the alarm.
In the United States, the issue ultimately did make it further up the ladder, reaching the desk of Timothy Geithner, who was chairman of the New York Fed at the time before becoming US treasury secretary. At the end of May, he sent an email on the subject of the Libor to the governor of the Bank of England, writing: "We would welcome a chance to discuss these and would be grateful if you would give us some sense of what changes are possible." Attached to the message were two pages of "Recommendations for Enhancing the Credibility of LIBOR". It was anything but a warning about manipulations.
At first, there was no reaction from the other side of the Atlantic, and Geithner's office had to send a reminder email on June 1. Two days later, Bank of England Governor Mervyn King finally responded, writing that the recommendations seemed "sensible" and that he would be happy to discuss the matter further with Geithner.
But nothing further happened in the ensuing months. The financial crisis was coming to a head with the bankruptcy of investment bank Lehman Brothers. The central bankers had other worries. This remains the regulators' line of defense today. If the world hadn't happened to be on the edge of an abyss, they say, the Libor scandal would certainly not have slipped through their fingers as easily.
Meanwhile, the US Commodities Futures Trading Commission (CFTC) had been investigating the issue since 2008, and its efforts eventually led to a worldwide investigation.
The Episode Is Blown Wide Open
"Mechanisms are now taking effect that I only knew of from mafia films," a shaken financial regulator said recently. Since investigations have gone into high gear in New York, London, Brussels and elsewhere, suspected bank executives have been coming clean.
They are under great pressure. Last year, the European Commission filed several antitrust suits against various banks. Antitrust suits are considered to be the sharpest weapons in business law because they allow Brussels to impose stiff penalties on cartel participants.
"In our investigations, we concentrate on suspicious cartel agreements that include derivatives. This includes possible secret agreements about the determination of these lending rates," says European Competition Commissioner Joaquín Almunia. In other words, the investigators are interested in more than the manipulation of global interest rates to benefit specific parties. It's also possible that the enormous market for derivatives was manipulated.
"Derivatives traders are also believed to have agreed upon the difference between the buy and sell prices (spreads) of derivatives, thereby selling these financial instruments to customers under conditions that were not customary in the market," says the Swiss Competition Commission, which is also investigating possible cartels.
It is difficult to find clear evidence, such as a written cartel agreement. But in Brussels alone, more than 40 banks have contacted authorities to report what they know about years of manipulation. The first star prosecution witness to reveal new information about a cartel and provides evidence stands to see his own fine eliminated entirely. The second can expect Brussels to reduce his fine by up to 50 percent and the third by up to 30 percent.
The European Commission can demand up to 10 percent of a year's profits from the banks. "There could be new record-breaking fines," says an employee at the Directorate-General for Competition in Brussels. Individual banks could expect to be slapped with fines of more than 1 billion by the EU.
In the United States, the Justice Department has joined financial regulators in conducting the investigations. This means that the scandal could also have criminal and not just civil consequences for a number of banks, say sources in Washington. Charges will likely be filed against at least one bank this year. US Congress has also announced plans to launch its own investigation.
It wasn't until the fall of 2011 that German financial regulators at BaFin headquarters in Bonn learned of the dimensions of the scandal from their counterparts in the United States and Great Britain. They had been largely unaware of the problem until then. Raimund Röseler, the chief executive for banking supervisor at BaFin, then prepared a special investigation, which has been underway since May.
What the Banks Could Now Face
German banks must have pricked up their ears when BaFin President Elke König recently spoke about the Libor scandal. "Basically, banks must establish suitable reserves for possible losses," König concluded.
Investors, like Vienna hedge fund FTC Capital, have made it clear that they do not intend to let up. They feel obligated to their customers to file claims for damages, explains FTC executive Majcen. Friedrich von Metzler, whose bank feels harmed by the rate manipulation through a fund subsidiary, has filed a lawsuit for the same reason.
There are already 20 lawsuits in the United States, some of which have been combined into class action suits. The plaintiffs range from the City of Baltimore to police and firefighter's pension funds, the City of Dania Beach, Florida, and Russian oligarch Vladimir Gusinsky.
They feel encouraged by the actions of regulators. "Both the American CFTC and the FSA have done excellent investigative work," says Majcen. Bank analysts expect that other institutions could face fines similar to the one imposed on Barclays. In fact, it ought to be in the banks' best interest to quickly settle their cases. "But they're afraid, because since Barclays, they know that it isn't just about money, but also about making heads roll," says a major shareholder of Deutsche Bank.
German attorneys are also lining up to represent potential clients. "A few institutional investors have already contacted us," says Marc Schiefer of the law firm TILP in the southern German city of Tübingen.
Years could go by before damage suits are ruled on. FTC executive Majcen expects that it will take until at least the spring of 2013 for the courts to decide whether to hear the cases, while the evidentiary hearings and trials could take another three to five years. Nevertheless, investment bank Morgan Stanley has already made its projections, estimating the total cost to the banks, including fines and damage payments, at $22 billion, of which $1.5 billion would apply to Deutsche Bank.
Possible Libor-related liabilities would cause serious problems at WestLB, or its successor company Portigon. The once-proud state-owned bank is in the process of being liquidated, at a cost of billions to its former owners, the western German state of North Rhine-Westphalia and savings banks. The Libor scandal could further increase the burden on taxpayers.
BaFin has launched a major offensive to determine whether WestLB and possibly other German banks were involved in the rate-fixing scandal. Letters were sent to all banks that assist in the calculation of the Euribor, giving them until last Thursday to explain their internal processes for calculating the euro interest rate and, most of all, their monitoring mechanisms. If responses suggest possible lapses, these banks could also see special auditors knocking on their doors.
Fund companies also received mail from Bonn. They were asked to determine which of their products are affected and, if possible, to report their possible losses.
Things will get especially uncomfortable for Deutsche Bank, because BaFin intends to double its regulatory capacities for the bank in the near future. Instead of two departments, there will be three or four devoted to Deutsche Bank. The regulator will reshuffle its internal organization to free up the necessary employees.
BaFin has also just prepared a position paper on a subject that is especially sensitive for Jain. The agency is now intensively addressing the question of how, in investment banking, the dangerous practice of proprietary trading could be isolated from the rest of the business through holding structures.
The regulators speculate that relevant draft legislation proposed by Britain's Vickers Commission could also apply to German banks. Nikolaus von Bomhard, CEO of insurance giant Munich Re and a member of the supervisory board of Commerzbank, Germany's second-largest bank, recently made the case for a breakup of major banks. Achleitner, a member of the board of Allianz under recently, was reportedly deeply upset about former colleagues in the industry.
The call for stricter regulation is also getting louder in politics once again. Sigmar Gabriel, chairman of the center-left Social Democratic Party (SPD), has discovered bank-bashing as an effective campaign tool, and has declared the next election, in the fall of 2013, as a "decision on the taming of the banking and financial sector."
Finance Minister Wolfgang Schäuble, a member of the center-right Christian Democratic Union (CDU), accused Gabriel, a potential SPD candidate for the chancellorship, of "cheap populism." But the remark sounded more duty-bound than genuine, especially given the fact that there is also considerable outrage over the Libor scandal in Berlin.
"This is a real zinger," says an insider. In the past, bank manager lapses resulted from their stupidity for having bought securities without understanding them. "Now that was bad enough. But manipulating a market rate is criminal." A portion of the industry, adds the insider, apparently doesn't realize that the writing is on the wall.
The parties involved, including Deutsche Bank and its new co-CEO Jain, cannot expect leniency when charges are investigated. "We can't make any allowances for high-profile names," say officials in the capital.
BY SVEN BÖLL, MARTIN HESSE, CHRISTOPH PAULY, THOMAS SCHULZ and ANNE SEITH
Translated from the German by Christopher Sultan
© SPIEGEL ONLINE 2012
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