The Antitrust Division's Dangerous Bluff with LIBOR

April 25, 2011

The London Interbank Offered Rate ("LIBOR") is the rate that banks in the London wholesale money-market reference when lending unsecured money to other banks. Essentially the mathematical mean of interbank deposit rates (for overnight to one-year maturities) offered by designated contributor banks, LIBOR is calculated daily by Thomson Reuters on behalf of the British Bankers Association ("BBA").

LIBOR is calculated for 10 currencies and each currency has a panel that comprises 8 to 16 participating contributor banks. Far beyond some esoteric computation, LIBOR has emerged into a powerful force in international commerce because it permits some standardization of lending activities among international banks.

Gilani's Warnings

In 2008, Shah Gilani (author of the popular Forbes financial column What Moves Markets) published his prescient commentary: Fears of Mortgage Rate Re-Sets May Fuel Libor Manipulation and Mask Deeper Banking Problems ("Money Morning" October 23, 2008). In that article, Gilani was among the earliest proponents of the theory that the contributing banks may have rigged the calculation of LIBOR. Gilani warned that such activities were likely antitrust violations and were exposing major international banks to legal liability.

The cursed Trojan prophet Laocoon's warnings about the Trojan Horse were ignored with calamitous consequence. With the LIBOR antitrust story looming on the horizon, we would do well to re-consider the alarms that Gilani raised some three years ago:

That brings us to the current problem in the LIBOR market: As Money Morning has previously reported, there's substantial evidence that LIBOR is being "managed." This has been happening and the BBA is actively looking into it. In fact, several months ago, when the BBA announced it was speeding up its probe, LIBOR jumped.

The dollar LIBOR rate, or "fixing," as it is known, is calculated based on the submission of quotes from 16 major world banks. The banks send in data as to what they paid, or could pay, to borrow from other banks at each maturity level. Reuters throws out the four highest and four lowest quotes, and calculates the average of the eight that remain to come up with the dollar LIBOR fixing.

[S]ince the submitting banks providing data to Reuters are on the "honor system," maybe this institution has an incentive to not submit its actual borrowing costs? Maybe this bank submits rates at which it could borrow - which it is permitted to do, by definition, under the submitting rules - if those rates are lower by virtue of only being a quote it received?

Maybe this bank - and the rest of its brethren - would like to keep LIBOR lower than the interbank rate should actually be, realizing that if rates rise, bad-loan exposure increases. And if bad-loan exposure increases, derivative exposure will escalate, too. What if U.S. ARM re-sets (based on LIBOR) bump up the interest-rate charges that already-strapped homeowners have to pay? What will more foreclosures do to already-battered bank balance sheets?

Told You So!

On April 20, 2011, Gilani's What Moves Markets column began with these ominous words concerning the potential impact of a LIBOR antitrust investigation:

This might be the beginning of the end for some too-big-to-fail banks.

In a recent Forbes column: Antitrust Criminal Charges Threaten Survival of Big Banks, Gilani informed us that the Department of Justice's ("DOJ") Antitrust Division is investigating whether as many as 16 major banks colluded from 2006 through 2008 as part of a scheme to manipulate LIBOR. Gilani adds further fuel to the fire with his ruminations about follow-on civil suits - particularly class actions. All of which begs the question:

If the Antitrust Division fires the first salvo against alleged rate fixing and anti-competitive activities, how serious a threat would such a warning shot pose to the banking community?

Past as Prologue

In 1996, the Antitrust Division had the chance to prosecute a major criminal case against the leading NASDAQ market makers. At the time, the Division had a strong case replete with tape recordings showing markets makers colluding to artificially maintain the spread and threaten other participants who sought to break that so-called pricing convention.

Despite a strong case, the Division inexplicably opted for a civil lawsuit and then chose the dubious convenience of a settlement. I would say "inexplicably opted" because given the impressive nature of the evidence that had been amassed, there seemed little reason for not taking the market makers out to the woodshed and sending an historic message to Wall Street about where it needed to draw the line in terms of double-dealing with the investing public.

However, I am too old and far too veteran a regulatory lawyer to pretend that I don't comprehend why the case went "civil." Big Business. Politics. Those words say it all. I decried the Antitrust Division's disgraceful retreat some 15 years ago and continue to point to that decision as a watershed moment that was squandered with horrendous consequences.

SIDE BAR: One can only wonder whether the filing of criminal charges in 1996 against some or all of the 24 NASDAQ firms named in the Antitrust Division's civil suit would have prevented the excesses in the subsequent decade that ultimately led us to the brink of catastrophe and the Great Recession. For those of you who forgot the names of those antitrust defendants, let this serve as a refresher:

Alex. Brown & Sons Inc.
Bear, Stearns & Co. Inc.
CS First Boston Corp.
Dean Witter Reynolds Inc.
Donaldson, Lufkin & Jenrette Securities Corp.
Furman Selz LLC
Goldman, Sachs & Co.
Hambrecht & Quist LLC
Herzog, Heine, Geduld Inc.
J.P. Morgan Securities Inc.
Lehman Brothers Inc.
Mayer & Schweitzer Inc.
Merrill, Lynch, Pierce, Fenner & Smith Inc.
Morgan Stanley & Co. Inc.
Nash, Weiss & Co.
OLDE Discount Corp.
PaineWebber Inc.
Piper Jaffray Inc.
Prudential Securities Inc.
Saloman Brothers Inc.
Sherwood Securities Corp.
Smith Barney Inc.
Spear, Leeds & Kellogg LP (Troster Singer)
UBS Securities LLC

The Obama Antitrust Initiative

Shortly after the last presidential election, the Obama Administration announced its much ballyhooed effort to enhance the enforcement efforts of the DOJ's Antitrust Division, which had become moribund under the Bush Administration. The 2009 appointment by Obama of lobbyist, fundraiser, and high-profile corporate lawyer Christine Varney was meant to underscore the administration's purported commitment to revitalizing the nation's antitrust laws.

Varney, whose credentials included heading up the law firm of Hogan & Hartson's Internet practice, a stint as a commissioner on the Federal Trade Commission, and a role in the Clinton administration, promised to follow through on her mandate. As always, there was a lot of tough talk and the attendant appointment of new Antitrust Division management and staff. Whether motivated by the desire to foster competition in our hobbled economy or by personal desires for headlines, the initial flurry of activity from the Antitrust Division was impressive. However, the political landscape is littered with the carcasses of overly ambitious appointees whose reach exceeded their grasp.

Timeo Danaos et dona ferentes

In 2011, the Antitrust Division appears overwhelmed by its Municipal Bond cases, the Google investigation, health care initiatives, the mega-mergers of the private sector, and the contentious status of the New York Stock Exchange's possible acquisition. Moreover, the historic internecine combat among the Antitrust Division, local U.S. Attorneys' offices, and the Federal Trade Commission has exacerbated antitrust enforcement amidst overlapping laws and jurisdictions. In the end, such infighting over turf and headlines is enervating to the respective staffs and does a disservice to taxpayers who lose the economies of scale that prudent mergers of jurisdiction and staffs would otherwise accomplish.

The Antitrust Division's financial and manpower resources are straining under the weight of many, perhaps too many, investigations and cases. Within the last year, there have been numerous retirements and resignations (if not demotions) of veteran staff, in part fueled by a mixture of early buyouts, new managerial policies, and workplace disputes. The rumored closure of the Division's Philadelphia and Cleveland field offices have sent shudders through those staffs and further fueled uncertainty in the ranks. Similarly, the Municipal Bond cases appear to have monopolized much of the Division's time and energy. Frankly, from a morale standpoint, this may be an historic nadir for the Antitrust Division and there seems little prospect of improvement.

As such, while it's interesting to read of the Antitrust Division's newly found focus on LIBOR, the reality of things suggests that the Division's rank-and-file is demoralized by bureaucratic micro-management. Additionally, the present political environment is demanding pay freezes, staffing reductions, and a smaller government footprint - all of which raise questions about how the Division intends to accomplish is ambitious agenda. Taking on yet another high-profile case may be the equivalent of opening the Antitrust Division's doors to a destructive Trojan Horse.

Assistant Attorney General Varney has shown a penchant for starting many wars, but it's doubtful that she retains the troop strength and morale necessary to effectively wage all the necessary battles. Of course, with a new presidential election season underway, who knows whether Varney's eye is already on greener pastures - be that a return to her former political/fund raising role on behalf of the Democratic re-election effort, or a return to the more comfortable quarters of private practice.

Notwithstanding the legitimate concerns raised by Shah Gilani and other Wall Street commentators, there are serious questions as to whether the Antitrust Division is spread too thin to take on yet another high-profile case - and there are also equally valid concerns as to the political will in the White House and Congress to support and sustain a battle with the banks. Much like the state of the US military that is unwilling to open yet another front in Libya or elsewhere, it's questionable as to whether the Antitrust Division can shift its remaining troops and weapons from one theater of operations to another without negative consequences.