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Sheila Bair Sees “Significant More Fallout” from LIBOR Scandal: “It’s Outrageous”

·Editor in Chief

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The U.S. market hasn't yet paid much attention to the LIBOR scandal that's gripped London, but it's getting harder and harder to ignore.

This week, the chair of the Senate Banking Committee announced he is calling Fed chairman Ben Bernanke and Treasury Secretary Tim Geithner to testify about allegations big banks manipulated LIBOR, a key lending rate in global finance. Separately, the chair of the House Financial Services subcommittee's on investigations petitioned the New York Fed for information about whether the central bank knew banks were low-balling their LIBOR rates during the crisis.

"I assume there is going to be significant more fallout" from the LIBOR scandals, says former FDIC chairwoman Sheila Bair, now a senior adviser to the Pew Charitable Trusts. "How severe and pervasive we just don't know yet."

There are actually two separate scandals here, Bair notes. The first is whether the NY Fed ignored reports of irregularities in the LIBOR market during the financial crisis, as U.K. regulators are alleged to have done.

"The Federal Reserve Bank of New York may have known as early as August 2007 that the setting of global benchmark interest rates was flawed," Reuters reports. "Following an inquiry with British banking group Barclays Plc in the spring of 2008, it shared proposals for reform of the system with British authorities."

The second is that, according to a CFTC complaint, traders at big banks actively colluded to manipulate the price of LIBOR from 2005-2008.

While declaring "it was all wrong," Bair says the allegations of price collusion among big banks is far worse than regulators condoning the low-balling of LIBOR rates during the dark days of 2008.

"Even at the height of the crisis you need to get accurate information out but I might be more understanding of that motivation vs. this collusive trading activity that was purely generated by greed," she says.

Games Bankers Play

Last week, Barclays paid roughly $450 million to settle charges by U.S. and U.K. regulators that its traders manipulated LIBOR. Most observers believe Barclays is just the first firm to settle; global regulators are investigating more than 10 other big banks, including UBS (UBS), JPMorgan (JPM) and Citigroup (C), and a federal grand jury is gathering evidence for potential criminal charges against individual traders, Reuters reports.

Led by the City of Baltimore, several U.S. municipalities have already filed lawsuits, seeking damages for interest rate swaps that were pegged to LIBOR. Analysts at Nomura Equity Research warn banks could be liable for "tens of billions" in related claims, The NY Times reports.

The Commodity Futures Trading Commission estimates over $800 trillion of financial instruments are pegged to LIBOR, including $350 trillion in swaps.

"Interest rate swaps are widely used and a very legitimate hedging tool," Bair says. "But you need integrity in the pricing mechanism. When they were based on LIBOR, at least from 2005-2008, there were a lot of games being played."

Echoing the comments here by Cumberland's David Kotok, Bair says this LIBOR scandal "absolutely" hurts confidence in the integrity of the financial market. However, she rejects the view -- commonly heard in conservative circles -- that regulators were to blame.

"Banks are responsible for their own actions," she says. "I cannot believe any regulators knew about what Paul Tucker called a 'cesspit'." (Tucker, a deputy governor at the Bank of England, testified before U.K. Parliament Monday after Barclays executives suggested he condoned LIBOR manipulation back in 2008.)

"It's sad there's not a culture of higher integrity" in the financial services industry, Bair says. "It just underscores why regulators can't defer to the industry itself when they have a self-interested conflict. You had a survey methodology [to determine LIBOR] that lent itself to manipulation. That never should have occurred."

For the record, Bair says she was unaware of any problems with LIBOR during her time at the FDIC. Still, she recalls press reports from 2007 and 2008 raising related concerns because LIBOR rates were set by a survey rather than specific transactions.

"My impression was the survey methodology left itself open to judgment," she says. "That said, this goes far beyond exercising subjectivity. These traders were actively colluding with others to submit information to the survey to manipulate the rates. It's outrageous."

It's an outrageous allegation, to be sure, and one that deserves a wider public hearing. Expect this LIBOR story to move to the front-burner in the days and week's ahead.

See also:

LIBOR Scandal Latest Sign of Financial System's Rotten Core

Why the LIBOR Scandal Matters: 'Destruction of Confidence to the Nth Degree'

Banks Are Safer But "Not Safe Enough": Former FDIC Chair Sheila Bair

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com