In this paper Peter Thompson uncovers the details of how the Libor scandal came about and the failures of financial news reporters and regulators to deal with the problem earlier. The account, while focusing on Libor, also sheds light on the reasons why so few failed to spot (or report on) the coming financial crisis of 2007-08, as well as why future crises are also likely to be missed until its too late. For a pdf of this paper please click here.
The Libor Scandal: Mediation and Information Issues
The evolution of financial markets has always been closely tied to new developments in ICTS (information and communication technologies) as well as to new regulatory regimes. With each new legal or technical shift so market actors have sought to find trading information advantages over others in defiance of institutional attempts to make market data universally accessible. Such shifts and adaptions have become all the more frequent in the City of London since ‘Big Bang’ (1985-6), which saw financial exchanges become globally networked in real time.
The response of financial institutions has been the development of increasingly sophisticated systems of financial calculation and new financial instruments to permit the exploitation of narrow margins; for example, by using derivatives to amplify leverage, or collateralized debt obligations and credit default swaps to spread risk. In turn, the institutional opacity and technical complexity of these developments has made it difficult to sustain routine journalistic scrutiny or regulatory oversight independent of insider sources.
The 2007-8 sub-prime mortgage crisis and ‘credit crunch’ that followed, in many ways reveals each of these processes and problems. The wider consequences of government bank bail-outs and subsequent public austerity measures has also generated debate about the relationship between financial markets and other sectors of society, including the role of the media. Consequently, critical media analysis of financial news reporting has enjoyed a recent resurgence (e.g. see Schifferes & Roberts, 2014; Starkman, 2014; Murdock & Gripsrud, 2015).
The diagnosis and magnitude of the media’s shortcomings in failing to identify the risks of sub-prime mortgage securities can be disputed. Nevertheless, the crisis certainly triggered a more critical tone in news reporting of banking. At face value, it might appear that the news media has rediscovered its appetite for adversarial reporting, challenging academic criticism that journalistic proximity and dependence on banking sources led to institutional and ideological capture.
However, that may be an over-simplistic reading of the changes that have taken place. Taking the Libor-rigging scandal as a focus, I want to argue that, while some aspects of financial reporting and banking practices have doubtless changed for the better, some deeper problems remain largely unaddressed. Understanding the nature of these problems requires consideration of the evolving institutional priorities of the media, financial institutions and regulatory bodies. It also needs recognition that the verification of financial facts and events in many ways remains dependent on disclosures from financial regulators and government agencies. The following discussion outlines some of the key events as the Libor issue unfolded and then proceeds to consider its implications for our understanding of the financial media.
The Libor scandal
The London Interbank Offered Rate (Libor) is an international benchmark for currency lending and FX trading originally developed in the 1980s by the British Bankers Association. The daily rates indicate the level of interest at which banks are able to source loans in different currencies over different periods. The estimated value of contracts and securities underpinned by Libor range from US$300 to $800 trillion (Wheatley Review, 2012[i]). Libor rates directly influence the daily flows of US$5.3 trillion in forex-related trades (BIS, 2013), derivatives contracts (FX futures, swaps and options) and bank loans (including mortgages and related securities).
Up to 2014[ii], Libor rates were calculated for ten major currencies across 15 periods (from overnight to a year, with 3 month figures the standard reference). A panel of up to 18 major banks were asked ‘At what rate could you borrow funds, were you to do so, by asking for and then accepting interbank offers in a reasonable market size just prior to 11am?’ The highest and lowest 25 percent were then discounted and the means of the middle range submissions were calculated and published by Thomson Reuters, ensuring that the entire market received the information simultaneously.
The revelations of Libor rate manipulation follow a rather uneven time-line (see BBC News 2013), because the salient events that were unfolding during the 2007-8 crisis period were not yet well recognised outside the financial institutions involved and also overshadowed by the magnitude of other crisis-related events, on which the majority of media attention was understandably focused. Libor only became a full-blown scandal when it hit the headlines in 2012, following the release of bank communication records revealing collusive activities among the panellist banks.
Misgivings about the validity of the submitted Libor rates had begun to percolate through the financial sector from 2005 (see Brummer, 2014; Davies, 2015). In late 2007, regulators became aware of mass distribution emails expressing suspicions about Libor rates being routinely under-estimated in case they engendered market perceptions of institutional vulnerability. Interestingly, around the same time, Barclays (which would soon become the primary focus of the Libor scandal) intimated its own concerns about Libor to the BBA and the Commodity Futures Trading Commission, albeit without admitting its own complicity in the practices (Federal Reserve, 2012; FSA, 2012; Wheatley Review, 2012). Meanwhile the New York Fed also received a call from a Barclays employee concerned about low-ball Libor submission practices (Federal Reserve, 2012; Miliken & Spicer, 2012).
At this time, Libor did begin to receive some attention by the financial media, but the magnitude of the malfeasance underpinning the system was not yet apparent. For example, the ever-prescient Gillian Tett (2007) wrote a piece in the FT which noted that the BBA had been receiving an unusual number of enquiries about Libor mechanisms and noted concern among some banks about differences between the official Libor rates quoted on Reuters and those available in the market (see Amadeo, 2014). The Wall Street Journal similarly carried reports which noted growing spreads between different bank borrowing rates (McDonald & McDonald, 2007; Gaffen, 2007). In April 2008, a month after the fire-sale of Bear Stearns following its creditors’ loss of confidence (see Thompson, 2014), the New York Fed Markets Group contacted the Barclays employee who had phoned them previously. The call confirmed that the banks were worried that high Libor submissions could make an institution appear weak in an environment where inter-bank credit was quickly evaporating (Federal Reserve 2012). The New York Fed Markets Group subsequently included a report on the accuracy of Libor rates in weekly briefing note. This appears to have been a trigger for the increase in news reports asking questions about the possibility of Libor manipulation (Federal Reserve 2012).
As the credit crunch deepened in the aftermath of the Lehman brothers collapse in September 2008, the valuation models underpinning a wide range of mortgage-based assets broke down (Thompson, 2014) the banking sector became increasingly paranoid about extending credit to counterparties holding large volumes of potentially toxic assets. Meanwhile, governments and financial regulators became increasingly concerned about market liquidity and the systemic risk of a breakdown in credit. As the crisis deepened, and banks stopped lending to each other, the transactions which might have provided an empirical referent for Libor submissions seized up (see Kregal, 2012; Thompson, 2013). As Brummer (2014) notes, the credit crunch led to spreads between banks’ actual lending and borrowing rates widening to over 1000 base points, leading the BBA to temporarily suspend publication of the Libor rates (see also The Economist, 2008). Although not a direct result of the manipulation, Libor had effectively lost any coherent meaning and functionality as a common benchmark. As (then) Bank of England governor, Mervyn King, quipped to a Treasury select committee, “Libor is the rate at which banks don’t lend to each other” (quoted in Brummer, 2014, p.175).
The trail of electronic evidence
As the rumours of rate manipulation spread, the financial media began to pick up the issue and raise more direct questions about the validity of Libor. However, the evidence of collusion stemmed not from investigative news reports but from regulator investigations requiring banks to divulge electronic communication records from financial chat rooms and trading room phone calls and messaging services (see Wheatley Review, 2012; Bloomberg, 2012. 2015b; Commodity Futures Trading Commission [doc b]). Although the trail of evidence implicated a wide range of banks, it also pointed to two somewhat different motives behind the Libor manipulation (see Kregal, 2012).
Firstly, the global crisis and the increasing reluctance of banks to issue credit to each other had led to extreme caution in the disclosure of any information with the potential invite perceptions of liquidity problems, especially given the recent examples of Northern Rock, Bear Stearns and Lehman Brothers (FSA, 2012; Federal Reserve, 2012). Submitting high rates relative to other banks invited speculation about solvency with potentially self-fulfilling consequences. Libor panel banks were also well aware of other banks gaming the system with their submitted rates, creating a perverse institutional-level incentive to collude or risk unfavourable comparisons. Comments in exchanges involving Barclays traders reveal the intention was to avoid public speculation about the bank’s liquidity. For example:
‘Try to get out JPY [Japanese Yen] Libors a little more in line with the rest of the contributors, or else the rumours will start flying about Barclays needing money because its Libors are so high’
‘going 4.98 for Libor only because of the reputational risk… basically the[re] is no money out there’ (both quoted in FSA 2012, p.25)
Secondly, on a micro-institutional level, the ‘Chinese walls’ between trading desks and the bank officials responsible for submitting the Libor estimates were evidently porous. The 2012 FSA report on the Barclays case suggests that submissions were adjusted by a maximum of 30 base points (0.30%) below the actual estimate rates. This may seem a very small amount, but it is potentially significant for forex and interest rate traders whose strategies often depend on exploiting small margins or spreads through leverage[iii]. Taking the Wheatley Review’s lower estimate of Libor-dependent securities of US$300 trillion, even a single base-point shift up or down in the rate could potentially make a difference of US$30 billion to forex trading positions over a year (which over a single trading day would be US$82.2 million). Given that many traders’ bonuses are performance-based, the incentive for illicit collusion for personal and institutional gain is clear.
Although senior management of the implicated banks typically denied direct knowledge of the micro-level interactions between individual traders, it is implausible that they were unaware of the institutional pressure to avoid giving any sign of vulnerability in the crisis and its aftermath. Moreover, the tenor of the electronic paper trail being followed by the regulators is indicative of simultaneous institutional tolerance of Libor manipulation practices and awareness that the practices violated regulations and that discretion and subterfuge were expected. For example:
‘Careful how we speak with them about what we, how the rate is set,’ (RBS trader, quoted in Bloomberg, 2012)
‘We’re going to get in trouble if we keep moving it up and down…’ (Deutsche Bank Trader, quoted in FCA 2015, p.15)
‘don’t talk about it too much … the trick is you do not do this alone … this is between you and me but really don’t tell ANYBODY,’ (Barclays trader to external counterparty, quoted in Slater & Ridley 2012)
Despite the tone of caution in some communications, other electronic messages suggest Libor manipulation had become widely tolerated as routine practice within some institutions:
‘Could we pl[ease] have a low 6mth fix today old bean?’ (Deutsche Bank trader, quoted in FCA, 2015, p.13)
‘If you need something in particular in the Libors i.e. you have an interest in a high or a low fix let me know and there’s a high chance i’ll be able to go in a different level.’(Unidentified FX trader quoted in CFTC document B, p.1)
‘look I appreciate the business and the calls we should try to share info where possible also let me know if you need fixes one way or the other’ (unidentified FX trader, quoted in CFTC document B, p. 6)
“Dude, I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger,” (email to a Barclays banker, quoted in Slater & Ridley, 2012)
The legal and regulatory response to Libor manipulation
The Libor investigations led to the series of formal proceedings and sanctions against the banks. It was also was clear that effective manipulation of the rates required collusion across multiple institutions. Although Barclays was the first bank to come to the attention of financial regulators, eight banks have now been fined by UK and US regulators for a total of around US$9 billion. These include Deutsche Bank [iv]($2.5b), UBS ($1.5b), Rabobank ($1.1b), RBS ($612m), Barclays, ($451m), Lloyds ($383m), ICAP ($88m) and RP Martin ($2.3m) (Bloomberg, 2015, June 24).
Although these fines are doubtless substantial, they are only a fraction of the banks’ annual profits, and they actively negotiated with regulators over the amounts to be paid to settle the matter (Bloomberg, 2015, 24 April). Consequently, some critics have interpreted the settlements as unduly cosy and suggested links between the ‘revolving door’ relation between industry and regulators and the lack of court prosecutions and custodial sentences (e.g. see Willett, 2013).
It is important, however, to note that the BBA Libor system was not based on statutory law, but a self-regulated market system. Proving that crimes were committed therefore is more complex than simply demonstrating that the Libor mechanism was being gamed. Nevertheless, 2015 saw the first UK jail sentence imposed on former UBS and Citigroup trader, Tom Haynes, for conspiracy to defraud (although the 14 year sentence is currently being appealed: Ridley, 2015). Barclays also settled a class action lawsuit on Libor issues for $20m back in 2014, but more recently US courts have ruled out claims against banks for Libor manipulation (Bloomberg, 2015, August 5).
Without diminishing the magnitude of the violations of professional ethics and fiduciary obligations the Libor rigging entailed, it is intrinsically difficult to calculate specific gains and losses for any party in direct relation to any individual Libor submission, or indeed, to apportion blame to any specific person or institution. Although Libor served as a common reference point around which a range of valuations and trading calculations were based, there are many other variables influencing FX-related asset values. Depending on the composition of investment portfolios and the particular positions/exposures taken on Libor currencies, a short term nudge of a few base points on a specific currency on any particular day would benefit as many investors as it harmed. Similarly, while Libor manipulation technically affected hundreds of trillions of dollars’-worth of assets, the material impact on the general public should not be overstated. Unless sustained over a longer period, daily fluctuations of a few Libor base points in interbank lending would not translate into any tangible shift in mortgage or credit card rates. These are more directly indexed to the domestic reserve bank rates rather than the international FX market. Although Libor was a public scandal but the parties most affected were large financial institutions.
A further complication in the Libor scandal which only came to light during the FSA investigations in 2012 was the question of how far the regulators and the government had been aware of, or even complicit with, the Libor manipulations at the height of the 2007-8 crises. In July 2012, on hearing details of Barclay’s Libor-rigging practices, BoE governor Mervyn King called several of its senior board members to a meeting. King explained that the regulators had lost confidence in Barclays and that the magnitude of the scandal required more than symbolic board resignations (Brummer, 2014). Both CEO Bob Diamond and chief operating officer Jerry del Missier duly resigned the day before they appeared before a Treasury Select Committee on Libor.
In the ensuing proceedings, Diamond revealed that a few weeks after the collapse of Lehman in September 2008, the deputy governor at the BoE, Paul Tucker, had called him to signal that senior government officials had concerns about Barclays Libor submissions which were consistently higher than other UK banks. According to Diamond:
‘Mr. Tucker stated the levels of calls he was receiving from Whitehall were senior and that, while he was certain that we did not need advice, that it did not always need to be the case that we appeared as high as we have recently’ (quoted in BBC 2012, July 3; see also July 9 & 16)
Diamond took a note of the call and discussed it with Del Missier, who informed the select committee that he understood this to be an instruction to bring Barclays’ Libor rates down in line with other banks. Tucker, meanwhile, acknowledged that a Cabinet secretary and Treasury official had discussed Libor rates with him, but strenuously denied that his conversation with Diamond could be construed as an instruction to rig Barclays’ submissions (BBC 2012, July 9; see also Brummer, 2014).
The evidence led to some speculation that senior government officials regarded Barclays as potentially vulnerable and after the series of recent banking failures, were willing to overlook discrepancies in Libor reporting if this served the goal of stabilising the sector. By 2008, the BoE and government would surely have become aware of reports that banks were low-balling Libor submissions to avoid reputational damage in a still-unfolding crisis, so it seems implausible that they knew nothing of this until 2012. However, as Kregal’s (2012) detailed analysis shows, there is no evidence to support more conspiratorial claims that the BoE and government knew about the level of collusion that preceded the crisis. Although there clearly was concern about stabilising the banking sector, the call to Diamond was better explained by Barclay’s continuing reluctance to accept the lines of credit that the government had extended to stabilise the banks, rather than any complicity with rigging Libor (Kregal, 2012). Nevertheless, insofar as the BBA, FSA and BoE were aware of possible discrepancies with Libor from at least 2007, questions remain about why it took until 2012 for the full story to be uncovered. As Brummer observes, ‘no-one thought to look under the bonnet to see just what was going on’ (2014, p.176).
The accumulation of communications records proving the extent of malfeasance led the Financial Services Authority to recommend an overhaul of the Libor model. (Wheatley Review, 2012). The British Banking Association’s oversight of Libor was roundly criticised and the call made for a new system to be put out to tender, which was won by the Intercontinental Exchange Benchmark Administration. ICE Libor now covers a smaller range of currencies, and although it still relies on responses from a panel of banks responding to the same question about borrowing rates, submissions must now reflect actual transactions, with legal prohibitions on making false claims. Moreover, the news model delays the publication of individual bank submissions to offset the risk of inviting speculation about liquidity[v]. Thomson Reuters also ceased to be the collator and publisher of the Libor rates.
Mediation issues and the aftermath of Libor
Given that the evidence about Libor manipulation began to emerge in the midst of arguably the most serious systemic financial crisis since 1929, the delays in investigation and resolution are perhaps understandable. The banks responsible have been sanctioned, and the shift to ICE Libor was a significant reform. Indeed, the FSA has itself been restructured into the Prudential Regulation Authority and Financial Conduct Authority (overseen by the Bank of England’s Financial Policy Committee) which are intended to render financial activities more transparent and prevent recurrences of such collusion and manipulation.
The media coverage of the crisis and, as the evidence came to light, the Libor scandal, evidenced a willingness to be critical of the financial sector (banks in particular) and avoid capture by elite financial sources (see Picard et al., 2014). The fact that Libor became a public scandal and that the reforms to the system have been pushed through is in large part attributable to the news media. However, despite some early reports which raised critical questions about the validity of Libor, the revelations of inter-bank collusion still relied on the disclosures from regulatory investigation. This suggests that even the financial media remained dependent on elite sources for information about internal market processes.
However, such limitations do not stem primarily from a lack of journalistic endeavour. It is important to recognise that financial events are not publicly accessible in the same way that, say, a public protest or a natural disaster would be. Financial events are ontologically embedded in networks of shared meanings and information flows to which only market participants have direct access. For example, the Libor rates themselves are an epistemic construct derived from the metrics and methods of calculation. Ironically their truth value depends not only on whether the panellist bank submit honest estimates but on whether the rates are collectively recognised as valid by the market as a whole. Although some journalists were sufficiently knowledgeable to discern problems with Libor from the anomalous spreads in the published data, the underlying causes of the anomalies were not. The networks of information exchange which underpin professional financial market activity are not usually accessible to outsiders (see Thompson, 2013; Davis, 2015). Consequently, journalists cannot easily verify the processes underpinning market events without sources at the coal-face,
It would be premature to suppose that the reforms that have ensued from the Libor scandal (and the more recent FX fixing scandal), coupled with the media’s willingness to be critical of the banking sector, will ensure market stability and prevent a recurrence of such problems. The authors’ recent interviews with both financial wire service editors/reporters, and investment bank traders/executives in the City of London[vi] suggest a shift in the relations between news media and the banking sector. Keen to minimise the risk of further reputational damage and regulator scrutiny, investment banks have introduced new restrictions on both internal and external communications. Internally, trading room protocols now routinely record all communications and regulate interactions with counterparties in other institutions. In some cases personal cell phones and social media have been prohibited. These measures are understandable, but it remains unclear how this would affect the kind of informal communications among traders in a crisis scenarios when benchmarks like Libor break down and price activity cannot be discerned from brokerage screens (see Thompson 2014). There is therefore concern that the new rules restrict entirely legitimate trading room communications. Some representative comments from bank interviews include:
‘In terms of observations and exchange of information, that’s one of the things that the regulatory regime now has, actually in terms of unintended consequences, nobody will share information with you any more…’
‘One of the customers made some comments about them checking pricing with other customers about what the other banks were offering. If the banks did that it would be called collusion or rigging the market. If I ring up [other banks named] and say “hey, how are you pricing [company name]?” and that’s recorded, that’s collusion’
Meanwhile, in regard to bank interactions with the news media, there has been a significant reinforcement of gatekeeping protocols to manage who responds to journalistic enquiries. The referral of reporters to PR departments and communications managers is far from new, but the tighter rules make navigating these channels more complicated and serve to restrict access to traders at the coal-face, as these comments from wire service reporters suggest:
‘Access to traders, decision-makers, deal-makers on the floor have become much, much more difficult, for a whole host of reasons. Obviously all the banks and institutions have tightened up massively on who they allow to speak to the press freely.’
‘There was a time, eight to ten years ago, where you would ring up the internal communications person and say can I talk to x y or z, Now they want to be in on the call and they will intervene if there’s a question asked that’s sensitive and they demand checking of quotes afterwards.’
There is no question that the Libor scandal revealed widespread unethical practices, although it is important to differentiate between cases where reputational damage control was the motive as opposed to personal greed. Many bankers are now weary of what they regard as relentless and (in some cases) unfair media criticism, although given that the Libor and subsequent FX fixing scandals followed a global crisis fuelled by unscrupulous subprime mortgage practices, one might argue that the banking sector has invited this upon themselves.
Although several interviewees suggested that the ostensibly incriminating communications which fuelled the Libor scandal were several years old and interpreted out of context by the regulators, there was nevertheless acknowledgement that the rigging was widespread and needed to be corrected. The more complex question is whether the measures introduced to prevent recurrences of such malfeasance have adequately recognised the constructed nature of metrics such as Libor. The new communication restrictions will arguably make it more difficult for traders to validate price action in a crisis scenario when the shared confidence in benchmarks like Libor break down (especially given that ICE Libor is now based on the very transactional data which dried up at the height of the credit crunch). Meanwhile, journalists may find it more difficult to access the financial sources who have direct experience of the events being reported. As with so many responses to financial problems, the solutions may inadvertently carry the seed of future problems.
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[i] Note that much of this is notional value of contacts whereas the total value of global financial assets excluding derivatives was roughly US$ 225 trillion in 2012 (McKinsey Global Institute, 2013). The fact that even expert regulatory bodies cannot determine a more precise value of assets influenced by Libor is indicative of both the complexity of contemporary financial securities and the extent to which investor and policy maker assumptions about market reality depend on the models of calculation employed.
[ii] Following the 2012 FSA inquiry (the Wheatley Review), the Libor model was restructured after tendering for a new overnight authority to replace the BBA. It is now administered by the Intercontinental Exchange Benchmark Administration (ICE).
[iii] Leverage entails borrowing capital for investment or the use of contracts (which cost only a few percent of their notional value) to amplify the returns (or losses) on a position. Highly leveraged positions are risky because even small price fluctuations may incur losses exceeding the base capital.
[iv] Deutsche Bank was fined relatively heavily because regulators regarded it as disingenuous in its dealings with investigators, not least because it destroyed evidence of phone conversations pertinent to the Libor case. In contrast, Barclays was fined a relatively smaller amount for admitting wrongdoing early and cooperating with the Libor investigation.
[v] For a comparison of BBA Libor and ICE Libor, see Murphy (2012) and ICE Benchmark Administration (2014).
[vi] These were conducted July-September 2014. Note that all interviews were conducted on the understanding of both personal and institutional anonymity, but they included several senior bank executives who had been working at institutions involved in the Libor issue in 2007-8.
Peter Thompson (email@example.com) is a senior lecturer in the media studies programme at Victoria University of Wellington. His main research interests concern media policy (especially funding mechanisms for public service media) and communication processes in financial markets. Peter is a founding editor of the Political Economy of Communication Journal and currently vice-chair of the IAMCR Political Economy section.