U.S. ASKS IF BANKS COLLUDED ON LIBOR / THE WALL STREET JOURNAL ( A MUST READ )

BUSINESS

APRIL 14, 2011

U.S. Asks if Banks Colluded on Libor

By JOSEPH PALAZZOLO, JEAN EAGLESHAM and CARRICK MOLLENKAMP

U.S. investigators are examining whether some of the world's biggest banks colluded to manipulate a key interest rate before and during the financial crisis, affecting trillions of dollars in loans and derivatives, say people familiar with the situation.

For the past year, law-enforcement officials have been investigating whether the U.S. and European banks understated their own borrowing costs, which are used to calculate the London interbank offered rate, or Libor. The investigators are now looking into whether the banks effectively formed a global cartel and coordinated how to report borrowing costs between 2006 and 2008.

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Libor is set every day in London, based on submissions by a panel of banks that report the rate they are paying to borrow.

The inquiry, led by the U.S. Justice Department and Securities and Exchange Commission, is analyzing whether banks were understating their borrowing costs. At the time, banks were struggling with souring assets on balance sheets and questions about liquidity. A bank that borrowed at higher rates than peers would likely have signaled that its troubles could be worse than it had publicly admitted.

Roughly $10 trillion in loans and $350 trillion in derivatives are tied to Libor, which affects costs for everything from corporate bonds to car loans. If the rate was kept artificially low, borrowers likely weren't harmed, though lenders could complain that the rates they charged for loans were too low.

Derivatives contracts could be mispriced because of any manipulation of Libor.

According to people familiar with the yearlong probe, U.S. regulators are focusing on Bank of America Corp., Citigroup Inc. and UBS, among others, and have sent subpoenas to those banks. The three banks declined to comment.

Graphic: Looking at Libor: Compare rates quoted by Citigroup, HBOS, J.P. Morgan and others with the Journal's calculations of the banks' actual lending costs, in a period lasting more than a year.

Inside the Justice Department, the case is being pursued by antitrust and antifraud prosecutors, said people familiar with the situation. Criminal antitrust investigations typically focus on collusive behavior such as price-fixing and bid-rigging. A number of the banks involved in the probe have hired high-profile corporate-defense law firms.

Spokesmen for the SEC and the Justice Department declined to comment. Collusion cases are hard to prove without email evidence or the testimony of a bank insider, legal experts say.

James Rill, a former assistant attorney general of the Justice Department's Antitrust Division and now senior counsel at law firm Baker Botts LLP, said prosecutors must show that an agreement existed among the banks, ideally with the help of at least two witnesses to corroborate the scheme. Absent witnesses, prosecutors would need to obtain documents or emails that clearly show collusion, Mr. Rill said.

Prosecutors have interviewed bank employees who could give a detailed explanation of how Libor was set, said a person familiar with the situation. UBS AG, the big Swiss bank, first signaled the probe last month in a securities filing, when it said it had received subpoenas from three regulators investigating "whether there were improper attempts by UBS, either acting on its own or together with others, to manipulate Libor."

Michael Volkov, a partner at Mayer Brown LLP and a former trial lawyer in the antitrust division, said the investigation raises the stakes for the banks, potentially exposing them to costly class-action lawsuits. In antitrust cases, successful private plaintiffs who were harmed by any manipulation are entitled to treble damages, or triple the normal amount.

Banks report their borrowing costs around 11 a.m. London time, and the data are collected and calculated by Thomson Reuters. The lowest- and highest-four rates are thrown out, and the two center quartiles are averaged. A collusion inquiry likely would focus on whether banks agreed with each other to report certain rates. The Libor-setting process is overseen by the British Bankers' Association.

A 2008 Wall Street Journal examination of the borrowing costs submitted by the banks showed that, at times, banks reported remarkably similar costs despite the fact that the banks were facing different financial stresses. For the first four months of 2008, for example, the three-month borrowing rates reported by the 16 banks remained, on average, within a range of only 0.06 percentage point. That compares with an average dollar Libor of 3.18% at the time.

In 2008, economists at the Bank for International Settlements, a kind of central bank for central bankers, raised concerns about whether the banks were reporting incorrect rate information. The economists said that although tossing the two outlier quartiles was likely to curb manipulation, Libor could still "be manipulated if contributor banks collude or if a sufficient number change their behavior."

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—David Enrich contributed to this article.

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