Charles Schwab Corp. (Largest Independent Brokerage) Sues Bank Of America, Citigroup For Manipulating LIBOR Rates; IMF Notes That LIBOR Underpins $400 Trillion In Financial Derivatives

Schwab Sues Bank of America, Citigroup for Manipulating LIBOR Rates; IMF Notes that LIBOR Underpins $400 Trillion in Financial Derivatives (Global Economic Analysis, August 25, 2011):

Investment News reports Schwab sues banks for manipulating Libor rates.

Charles Schwab Corp., the largest independent brokerage by client assets, sued Bank of America Corp., Citigroup Inc. and other banks claiming they manipulated the London interbank offered rate, or Libor, starting in 2007 in violation of U.S. antitrust law.

The banks conspired to depress Libor rates by understating their borrowing costs, thereby lowering their interest expenses on products tied to the rates, according to the lawsuit filed Aug. 23 in federal court in San Francisco, where Schwab is based.

The banks “reaped hundreds of millions, if not billions, of dollars in ill-gotten gains,” Schwab wrote.

In separate suits in April, three European asset-management firms and the Carpenters Pension Fund of West Virginia sued the banks claiming they manipulated Libor. U.S. and U.K. officials are cooperating in a probe of possible Libor manipulation, a person close to the investigation said in March.

The Schwab suit seeks unspecified damages, which may be tripled under antitrust law. It also includes claims for racketeering and securities fraud.

Did the banks manipulate LIBOR? Of course they did. Proving it may be difficult.

LIBOR stands for London Interbank Offered Rate. It is the rate at which banks would lend top each other.

LIBOR is a rate at which banks say they would lend. However, it can easily be manipulated because it does not represent real transactions.

Previous LIBOR Manipulation Charges

Wikipedia describes previous LIBOR Allegations nicely.

On Thursday, 29 May 2008 the Wall Street Journal (WSJ) released a controversial study suggesting that banks may have understated borrowing costs they reported for LIBOR during the 2008 credit crunch. Such underreporting could have created an impression that banks could borrow from other banks more cheaply than they could in reality. It could also have made the banking system or specific contributing bank appear healthier than it was during the 2008 credit crunch.For example, the study found that rates at which one major bank “said it could borrow dollars for three months were about 0.87 percentage point lower than the rate calculated using default-insurance data.”

To further bring this case to light, the Wall Street Journal released another article dealing with this matter titled “U.S. Probe Presents Dilemma over Libor” on Friday, March 18 2011. The article stated that regulators are focusing on Bank of America Corp., Citi-group Inc. and UBS AG. Making a case would be very difficult because determining the LIBOR rate does not occur on an open exchange. According to people familiar with the situation, subpoenas have been issued to the three banks.

In October 2008 the International Monetary Fund published its regular Global Financial Stability Review which also found that “Although the integrity of the U.S. dollar LIBOR-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding.”

LIBOR Underpins $400 Trillion in Financial Derivatives

The IMF Global Financial Stability Review states “LIBOR rates are estimated to underpin some $400 trillion of financial derivatives contracts”.

That is a direct quote on PDF page 16 if the IMF review. It clearly shows why banks have a huge incentive to lie.

Am I the only one who thinks $400 trillion tied to a made up number is insane? Hells bells, $400 Trillion riding on LIBOR would be insane even if the number was real. Heck, $400 Billion would still be insane.

Here is an interesting snip from PDF page 93 (report page 74) “given the huge outstanding amounts of derivative contracts and other financial instruments linked to term LIBOR and Euribor, these benchmark rates need to be maintained. Although the survey methodologies have been effective at eliminating most biases at the individual contribution level, proposals by the British Bankers’ Association (BBA) to increase the number of sampled banks and introduce more aggressive scrutiny of individual bank contributions are welcome.”

It is staggering that there can be $400 trillion in derivatives based on LIBOR but there you have it. The number sounds impossible but the Bank of International Settlements shows there were $601 trillion in derivatives as of December 2010.

Of that number $465 trillion was interest rate contracts. For comparison purposes, a mere $65 billion is bet on gold.

Total Over-the-Counter Derivatives

click on table for sharper image

Bear in mind that $465 trillion on interest rate contracts is a “notional” amount. The actual market value of interest rate bets is a mere $14 trillion, and total derivatives a mere $21 trillion.

What a relief!

From the IMF Report ….

Box 2.2. Is the LIBOR Fix Broken?

Market observers have been expressing concerns that some LIBOR contributors submit rates that are too low, particularly when they are facing liquidity constraints (Mollenkamp and Whitehouse, 2008). This is said to be driven by the requirement of the British Bankers’ Association (BBA) that all rate submissions be published, and by the fact that banks facing liquidity strains may not want to reveal the higher market rates they are actually being offered.

Box 2.3. The Federal Reserve’s Term Auction Facility

In December 2007, the Federal Reserve announced a temporary Term Auction Facility (TAF) that enabled U.S. banks to borrow for four weeks against the wider range of collateral permissible at the discount window.


Short-term funding markets in mature economies have been under stress for an extended period despite extraordinary policy interventions by central banks to widen the availability of secured liquidity. Although interbank lending is no longer the principal source of bank term funding, wide spreads are not simply arising from the method for calculating interbank rates and are principally driven by concerns about banks being in significant distress, with U.S. dollar liquidity strains also representing a significant factor in the euro money market.

Further, evidence of disruptions to bank and near-bank financing markets indicates that the transmission of policy interest rate changes are less certain and reliable. Policy interventions to further broaden access to emergency liquidity may continue to contain systemic risks but are unlikely to resolve the crisis until broader policy measures are implemented.

The paragraphs I highlighted do not exactly match the one sentence Wikipedia found buried in the middle of the report: “It appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding”.

Second Lawsuit in Six Weeks

This is the second LIBOR Lawsuit in the last six weeks. Last month Eldorado Trading Group LLC filed a lawsuit accusing a group of banks of conspiracy. See Trading Firm Accuses Bank of America, JPMorgan, UBS, and Citigroup of Conspiracy to Manipulate LIBOR

I do not think there is collusion here, rather they all lied because it was in their best interest to lie. Did they lie? Of course. Good luck proving it.

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