Stateline Story

More States Dig into Libor Scandal

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Several U.S. states have joined the investigations swirling around the illegal manipulation of the bank-to-bank interest rate known as “Libor” — an international scandal that may have cost governments and consumers billions of dollars.

Libor is a shorthand term for the London Interbank Offered Rate, a key measure that sets the basis for interest rates on financial instruments around the world. The attorneys general in Connecticut and New York have led the charge thus far, working together since early this year.

Regulators in the U.S. and the United Kingdom have charged that some banks manipulated Libor as they reported borrowing costs, either overstating or understating the figures to depress or inflate the rate. Some contend the false reporting was an attempt to puff up a bank's standing – lower costs, for example, would signal lower risk. Others see more systematic manipulation, a deliberate rigging to squeeze higher profits.

The ballooning scandal has touched more than a dozen prominent financial institutions on multiple continents, and it may have had a worldwide impact on trillions of dollars worth of securities, debt and trades. State officials are interested because the rate-rigging may have cost American municipal debt issuers and taxpayers as much as $6 billion.

“It comes out to a big number,” says Peter Shapiro, managing director at Swap Financial Group. “That would've been available to hire teachers or police officers or make investments for the public good.”

In addition to New York and Connecticut, Massachusetts, Florida and North Carolina have confirmed that they are formally investigating the matter. Maryland is contemplating a formal investigation, and several other states are quietly participating in the effort as well.

“The Attorneys General will follow the evidence wherever it leads,” Connecticut Attorney General George Jepsen's office vowed several months ago, “with the goal of providing restitution to state agencies, municipalities, school districts and not-for-profit entities nationwide that may have been harmed by any illegal conduct.”

Libor Explained

Libor is set each day based on an average of banks' borrowing costs – essentially the interest charged on money moving between them.

Those self-reported costs from the banks are calculated and averaged, establishing a given day's Libor. That figure becomes the basis for interest rates on a host of transactions such as billion-dollar government debt deals and swaps to student loans and consumer credit card purchases.

For states and other governments, the implications of the scandal are enormous. They may have paid too much while Libor was inflated, or received too little if it was depressed. There's also the effect on  debt-holders. It's possible they lost millions.

So far, only the London-based multinational bank Barclays has admitted to manipulation, paying a settlement of $450 million to officials in both the U.S. and United Kingdom. Other resolutions have been slow to materialize as investigations continue on both sides of the Atlantic.

The Barclays settlement has sparked additional legal action. A federal lawsuit filed last year in New York by the city of Baltimore, a Connecticut city's firefighter benefit fund and others also has become an important legal beachhead.

The judge in that case is currently considering a motion to dismiss the suit, but in the meantime, other public entities are coming forward. New York's Nassau County says it lost $13 million. CalPERS, which manages pension and health benefits for public employees in California, is looking into whether it lost money, and a congressional panel has opened an investigation of its own. Barraged by new filings, the judge in the Baltimore case has ordered a stay on additional ones until she resolves the dismissal motion.

An attorney with Hausfield, LLP., the lead counsel in the Baltimore case, declined to say whether the firm is working with states on their inquiries, but the suit is seen as an important test for other governments investigating their own potential losses. States are also reportedly working with former high-profile investment bankers to mount their case.

Complex is an ‘Understatement'

Resolution could be a long time off. Experts say investigators will face significant challenges just identifying losses, even before wading into a full-scale investigation and mounting a case.

“It's an understatement to say it's big,” says William Butterfield, an attorney on the Baltimore suit, “it's an understatement to say it's complex.”

First, governments will have to determine what portion of their portfolios was subject to Libor and how it affected borrowing costs. Many of the transactions involve exotic arrangements with multiple parties, making even that step a challenge.

After that, states will have to determine whether their interest rates were set when the alleged rigging was taking place. Those rates are sometimes set weekly, or even daily, meaning officials may have to pore over years worth of data.

Only then could investigators determine the interest paid based on Libor's level at the time and go on to make a case for what the interest should have been if not for the alleged manipulation. That calculus will be based at least partially on assumptions sure to come under fire in court.

Some governments were receiving payments based on the Libor rate, while others were making payments, depending on the financial instrument in question. That means the financial effect of manipulation could change case by case.

In theory, an artificially high rate could mean one state paid too much on debt, while another received more in interest than it should have on a different financial instrument. The reverse is true for artificially low rates: one may have paid too little, while another wasn't paid what it was owed.

Legal Hurdles

As difficult as the unwinding of financial transactions is likely to be, the arithmetic is just one part of putting together a case.

Beyond defending the financials in court, states may have to identify which institutions are responsible. Because Libor is an average, even if one or two banks admit manipulation, they could argue that the aggregate nature of the rate diminishes their liability – unless every bank was involved, too.

As James Cox, a law professor at Duke University, put it: “If it doesn't translate to one hell of a lot of money, you'll never get a lawyer to take this case on.”

But those challenges, Cox says, also make it difficult – if not impossible – to file a class-action lawsuit or strike a global settlement akin to the resolution of the mortgage lawsuits filed after the financial crisis.

Every claim could have to clear those hurdles on its own merits and financials, even if the overall manipulation is known to have affected Libor-based rates around the world. What's more, a given government could have multiple financial dealings all affected by any Libor rigging in different ways.

“This is going to drag on for years,” Cox says.

Political Calculus

One reason some states may be reluctant to discuss investigations is that they are up against some of the most powerful financial institutions in the world. “If you need to go out and borrow $3 billion there are only a handful of Wall Street firms that can handle that deal,” says Justin Marlowe, an associate professor at the University of Washington Evans School Of Public Affairs. “You have to be really careful beating them up in the press knowing that in the next couple months you might have to go back and ask them to underwrite your next bond deal.”

But there are also risks to proceeding too cautiously. Different statutes of limitations apply to various state and federal laws, but much of the alleged manipulation dates to 2008 or earlier, meaning a common limit of five years is approaching. Federal investigators have sought agreements with banks to waive limitations to allow for fuller investigations and avoid haphazard charges from being filed.

It is so difficult to follow all of the jockeying around the Libor investigation that the Wall Street Journal has established a streaming online tool that aggregates every development, and the financial press has doggedly pursued each scrap of information. The Journal reported just last month that Connecticut and New York had subpoenaed nine more banks in their investigation.

Last week, New York Attorney General Eric Schneiderman declined to disclose details but said his office's broader inquiry into alleged financial improprieties is still in full swing, and he expects more lawsuits to follow. “We're a long way from wrapping this up,” he said.