Federal regulators had evidence that major banks could be manipulating one of the world’s most important interest rates a year before the practice came to an end, according to documents released by the Federal Reserve Bank of New York on Friday.
As early as 2007, the officials at the New York Fed suspected that this key rate, which serves as the basis for the interest rates that consumers pay on many loans, did not accurately reflect market forces, the documents show. Then, in April 2008, the New York Fed was explicitly warned by an employee of the British bank Barclays that it was participating in a ruse to “fit in with the rest of the crowd,” referring to other major banks.
The documents, released in response to congressional inquiries, add to the mounting questions about whether federal regulators were aggressive enough in addressing irregularities at the heart of the global financial system.
The new disclosures show that the New York Fed shared its concerns about the London-based Libor rate with British regulators. But the Fed offered no evidence that it had taken additional steps, including exercising its own authority as the regulator of some of the largest U.S. financial firms, to address the rigging of the rate.
“The New York Fed helped to identify problems related to LIBOR and press the relevant authorities in the UK to reform this London-based rate,” the Fed said in a statement. The Fed declined to say what other steps it might have taken and is still exploring whether there are more details it can release.
The manipulation by Barclays did not end until some point in 2009, offering the freshest evidence of how regulators struggled to oversee the largest banks during the global financial crisis.
The scandal involving Libor blew into the open late last month when Barclays paid a $450 million fine and admitted it had manipulated the rate.
Libor is set by 18 of the world’s largest banks, including U.S. giants JPMorgan Chase, Bank of America and Citigroup. Each bank reports its cost for borrowing money and these figures are used to calculate the Libor rate.
In the newly released documents, a Barclays employee is quoted telling a New York Fed official, “We know we’re not posting um, an honest Libor . . . If we didn’t do it, it draws, um, unwanted attention to ourselves.”
Barclays reported that its borrowing costs were lower than they really were in an effort to make the bank look healthier than it really was. Lower interest rates would mean that other banks considered Barclays to be less risky and also that Barclays could save money on borrowed funds.
Libor is the benchmark for a wide range of lending, including student loans, credit cards and some mortgages. Corporations, pension funds and municipalities based some of their investments on the benchmark rate.
Dozens of states, cities and other government entities are now exploring whether they lost money because of the alleged manipulation of this crucial benchmark. They say they may have been robbed of millions of dollars in returns on investments
By keeping the rate artificially low, banks also would have been giving global investors a rosier picture of the health of the world’s financial system. At the time, the global economy was engulfed in a financial crisis and panic was spreading. A rosier picture might have been welcomed by some regulators, who were struggling to keep credit flowing and stave off a new economic depression.
Still, manipulation of Libor was unlawful and part of the far wider illegal activity that took place on Wall Street before and during the financial crisis. Some banks took out fraudulent loans, pooled them into investments and sold them to investors around the world, souring the financial system. Some banks lied about the extent of the risks they were taking. After the recession ended, banks took advantage of homeowners facing foreclosure.
The release of documents by the New York Fed comes in advance of Treasury Secretary Timothy F. Geithner’s scheduled appearance in Congress this month to testify about the Libor scandal. Geithner was the head of the New York Fed from 2003 through 2008.
The New York Fed, which is the primary regulator of Wall Street, first noticed problems in the Libor market in 2007, according to the documents.
“Suggestions that some banks could be underreporting their LIBOR in order to avoid appearing weak were present in anecdotal reports and mass-distribution emails, including from Barclay,” the Fed document said.
Around this time, financial markets were weakening amid growing concerns about the mortgage market. On April 11, 2008, a Fed analyst asked a Barclays employee about problems in Libor reporting.
“The Barclays employee explained that Barclays was underreporting its rate to avoid the stigma associated with being an outlier with respect to its LIBOR submissions, relative to other participating banks,” the Fed document said. “The Barclays employee also stated that in his opinion other participating banks were also under-reporting their LIBOR submissions.”
Concerns about Libor were circulated throughout the New York Fed — and also sent to Federal Reserve headquarters in Washington, other regional Fed banks and the Treasury Department.
In April and May 2008, New York Fed officials met to address problems with Libor, and Geithner raised concerns with other regulatory agencies on May 1.
A month later, after Fed officials met with British authorities to express concerns, Geithner e-mailed Mervyn King, the governor of the Bank of England, with recommendations for improving the process.
King responded that he would send the New York Fed’s recommendations to the British Banks Association. The New York Fed said it continued to look for problems related to Libor.