The Libor chasm

18 July 2012 | By Vanessa Drucker

Investors keep blithely buying American and international banks. They need not lose sleep over the recently announced penalties against Barclays of $453 million, which amount to a slap on the wrist. If that were the full extent of the punishment, banks might even benefit, profiting from their transgressions.

The greater risk is that the Libor scandal could generate “potentially limitless” damages, arising from class action suits, based on losses in consumer products (home equity lines of credit, auto or student loans) and institutions (derivatives sold to municipalities and pension funds, swaps and floating rate notes, fees in absolute-return and hedge fund strategies). That’s just the beginning.

Class actions have previously bruised pharmaceutical and tobacco companies, but Libor litigation could be more drastic. Basically, before 2007, as Barclays and possibly other banks pushed rates to artificially high levels, consumers were burned; after the financial crisis, as Libor rates were unnaturally depressed, governments suffered when they bought swaps on a false assumption that rates would keep rising. While some plaintiffs are joining forces, others, like Charles Schwab are filing individual actions.

Plaintiffs will need to show that (one) they have lost money, due to, (two) Barclays or others’ rate rigging actions during the period in question. Since 16 banks are involved in setting Libor, you might imagine safety in numbers would offer protection. Already, a group of international regulators are probing beyond Barclays, including Deutsche Bank, Citigroup. Bank of America, Lloyds, RBS and Credit Suisse. Currently 18 banks submit LIBOR estimates, although that number fluctuates. Remember, however, that strict American antitrust laws also prescribe treble damages for collusion, or racketeering in the form of systemic manipulation.

Private plaintiffs are straining at the bit. Suppose lawsuits eventually compel banks to pay out vast sums, depleting their coffers. Would regulators wish to subject their industry to another body blow? That’s the rub. Gary Gensler, Commodities Futures Trading Commission chairman, says, “all rely on the honesty of benchmark rates like Libor”. Financial markets rely on confidence and the enforcement of legal contracts. If those precious characteristics are compromised, the loss of public faith could dwarf even astronomical legal damages.

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^{Vanessa Drucker is the American Editor of Fund Strategy, based in New York City. She has worked as a financial journalist for 20 years. In the 1980s, she practiced banking and securities law on Wall Street, and is the author of two business novels. Vanessa can be contacted at vanessa.drucker@centaur.co.uk.}

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