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Libor Investigation Extended to US Mortgages, but What About TALF Loans?

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A good report by Shahien Nasiripour recounts that the OCC has woken up to what a hot potato the Libor scandal has become, and has identified the mortgages that might (stress might) have been hurt by the rate diddling.

To start with, the universe that might have been affected is not that large. Per the Financial Times account:
There are at least 900,000 outstanding US home loans indexed to Libor that were originated from 2005 to 2009, the pe

riod the key lending gauge may have been rigged, investigators have said. Those mortgages carry an unpaid principal balance of $275bn, according to the Office of the Comptroller of the Currency, a bank regulator…

The number of US home loans in the OCC study represents 3 per cent of mortgages originated from 2005 to 2009.

As we’ve said before, it is not yet clear whether US mortgage borrowers were affected, since the priorities of the manipulators in the case of Barclays was improving the price of their derivatives positions, and then in the crisis, lowering their Libor posting to help look healthier than they were.

So far, the e-mail disclosures indicate that one month and three month Libor were manipulated, not six month Libor, which is a benchmark used for adjustable mortgages. Now it’s probably not a bad bet to figure that six month Libor was gamed now and again. But the intervention would had to have taken place on an interest reset date, and to hurt borrowers, it have had to be higher.

Even if you assume that all borrowers were adversely affected for 3 years, to the tune of 5 basis points for the period, you get $275 billion x 0.05% x 3 = $412 million. More likely is you have specific cohorts that were adversely affected for shorter periods, say $50 billion for 1 year for 10 basis points (which is still generous) or $50 million. Of course, these damages could be trebled under the Sherman Antitrust Act, but these are high side estimates.

By contrast, as we’ve indicated, the real action was in the derivatives, and the damages are likely to get much higher there. And municipalities were often on the wrong side of bank fancy footwork. These cases all relate to when Libor was understated in the crisis, and then the manipulation was believed to be much larger than in the pre-crisis period (10 basis points would be a big number from the earlier period; reader comments during the crisis indicate 30 or even 40 basis points would not be unusual). From the Economist in April:

Civil cases brought by banks’ customers in America suggest who might have suffered if the rate was being gamed.

These cases can be grouped into four types, according to Bill Butterfield and Anthony Maton of Hausfeld, a law firm. First, there are large individual investment firms seeking damages on their own. The other three types of case are brought by customers acting as groups. One group includes traders who were on the wrong side of LIBOR bets. A second group includes investors in large companies’ LIBOR-linked debt who may have lost out on interest payments if LIBOR was set too low.

The final group is made up of customers that bought interest-rate swaps from banks. This group includes the city of Baltimore, which is represented by Hausfeld and whose case is especially revealing…

Baltimore entered into over $100m in interest-rate swaps, according to case documents. Lower LIBOR-linked payments to the city would have meant less money to cover the outgoing fixed-rate payments. If LIBOR was artificially suppressed, the city would have been losing millions annually.

If the case is upheld, damages could be big. The American cases are being pursued under “class action” litigation. This means that if Baltimore’s case is upheld other cities sold the same products will also be able to claim damages. Across America 40 states allow municipalities to enter into swap agreements. The total estimated amount in 2010 was $250 billion-500 billion, according to an IMF paper. What’s more, cases are being brought under the Sherman Act, America’s antitrust law, which allows for triple damages. Assume the worst and damages for American cities alone could go as high as $40 billion.

One area we hope will be investigated is the impact on TALF borrowing. Some of the loans were priced off Libor, raising the specter that the banks might have gamed the rates not just for advertising purposes, but to game these programs. From the Federal Reserve Bank of New York’s website:

The interest rate on TALF loans secured by ABS backed by federally guaranteed student loans will be 50 basis points over 1-month LIBOR. The interest rate on TALF loans secured by SBA Pool Certificates will be the federal funds target rate plus 75 basis points. The interest rate on TALF loans secured by SBA Development Company Participation Certificates will be 50 basis points over the 3-year LIBOR swap rate for three-year TALF loans and 50 basis points over the 5-year LIBOR swap rate for five-year TALF loans. For three-year TALF loans secured by other eligible fixed-rate ABS, the interest rate will be 100 basis points over the 1-year LIBOR swap rate for securities with a weighted average life less than one year, 100 basis points over the 2-year LIBOR swap rate for securities with a weighted average life greater than or equal to one year and less than two years, or 100 basis points over the 3-year LIBOR swap rate for securities with a weighted average life of two years or greater. For TALF loans secured by private student loan ABS bearing a prime-based coupon, the interest rate will be the higher of 1 percent and the rate equal to “Prime Rate” (as defined in the MLSA) minus 175 basis points. For other TALF loans secured by other eligible floating-rate ABS, the interest rate will be 100 basis points over 1-month LIBOR.

Note again that some of the loans were priced off one-month Libor, which per the Barclays disclosures, were among the maturities manipulated; these are clearly a place to start (I leave to readers to take up the swap spreads discussion).

But even though the size of the market alone is bound to engender discussion of who was hurt and how much, in some ways, that misses the point. When people go to conduct business, they expect (or at least once did) to be treated fairly by vendors. And it wasn’t that long ago that regulators would come down hard on firms that broke the rules, not based on any computation of damages, but on the idea that certain types of behavior were not tolerated. For instance, in 1991, the CEO of Salomon and three other top executives resigned because the firm had waited weeks before informing the Fed of how a senior trader was submitting fake customer bids at Treasury auctions so he could buy more than the maximum allowed to a single firm. Mind you, the ire of the Fed was not over the violation per se but the casualness (which they saw as intransigence) of Salomon in reporting and dealing with it. Even with the magnitude of the Libor scandal, the posture of the OCC suggests that regulators will focus on ferreting out who was hurt. That’s a part of the process, but far more important is trying to restore integrity of the system. Yet we don’t see the sort of stern talk that says they recognize that this is part of their job.

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21 comments

  1. skippy

    If the inter bank rate[s were affected, regardless of other rates (time capture), would not every other rate[s be effected over increasing event horizons?

    skippy… survival of the fittest… electron of price… sigh.

    1. David

      I suppose so, but other rates (Treasury rates, corporate bond rates, all those other rates that are determined in actual auctions or markets rather than “I told the truth, Scout’s honor” like LIBOR, may just quietly take into account that LIBOR is gamed this way or that.

      They can talk to the LIBOR guys and see actual transactions.

      They are traders and know how traders react to incentives. This is pretty obvious to anyone who’s ever worked on a trading floor: LIBOR is made to be manipulated.

  2. Richard

    Yves,

    Excellent post. The fact that we don’t see regulators trying to restore the integrity of the system is that it puts them on a slippery slope.

    Everyone now knows they are dealing with liars (that is what the banks confess to when admitting to manipulating Libor).

    The bar for restoring integrity has been raised greatly.

    Hitting the banks with fines is not adequate. How can trust be restored?

    The very process of trying to restore trust might open up the Pandora’s Box of what truly bad behavior the banks have engaged in. In the short term, this could reduce trust even more.

    1. David

      Trust can be restored by using actual market prices, rather than the moronic LIBOR system.

      Or else we could expect traders to all become saints.

      Which transformation do you think is more practical?

  3. Up the Ante

    Having worked for the Center for Investigative Reporting, Mr. Nasiripour knows how to do investigative reporting.

    I would STRONGLY suggest he arrange an interview with Julie Williams, the ‘woman who Exudes conspiracy’, now, to rectify this,

    ” .. the posture of the OCC suggests that regulators will focus on ferreting out who was hurt. That’s a part of the process, but far more important is trying to restore integrity of the system. Yet we don’t see the sort of stern talk that says they recognize that this is part of their job. ”

    The OCC will find out who was hurt, yes, and will shield the banks.

    Surely municipalities’ corporation counsel will be interested in recovery, if not counsel for individuals ??

    http://www.pbs.org/wgbh/pages/frontline/shows/credit/interviews/williams.html

    Wasn’t this deadened-eyeballs likeness in that xtrevilist poster ?,
    http://www.pbs.org/wgbh/pages/frontline/shows/credit/art/williamsp.jpg

    The Gang Rape of Lady Liberty has emotional consequences, evidently,
    http://www.nakedcapitalism.com/wp-content/uploads/2012/06/Screen-shot-2012-06-13-at-10.58.53-PM.png

  4. ambrit

    Friends;
    “When people go to conduct business, they expect (or at least once did) to be treated fairly by vendors.”
    I’ll argue that FDR labored mightily to preserve Capitalism from the results of its’ own follies. Thereby saving the then existing social contract, which, under the new rules, did very well up until the NeoCons began to gain traction. What I see as happening now is a struggle to eliminate that older Hybrid Capitalist social contract. When Herr Hitler did something similar in the 1930′s all Hell broke loose. When Lenin and the Bolsheviks did so in Russia in the 1910′s all Hell broke loose. If the NeoCons manage it this time here in the West, do they expect a different result?
    Such delusional thinking seems to be par for the course. Ideologues revel in such out of touch world views. FDR’s strength appears to have been in his hardheadedness and willingness to listen to his brains trust. Then he, always the consummate politician, figured a way to get the thing done. What do the present pretenders to the throne boast as their intellectual capital; Rove, Norquist, the Chicago Schoolboys? No wonder all those AKs are flooding into Greece. By the way, anyone had a look at the US gunned up figures lately?
    We’ve gone way beyond looking for a fix for a financial peccadillo. The social contract is in play now.
    Cheers.

  5. sierra

    Jimmy Dee (Dimon) must be seriously giggling watching his story pushed off the main stream press!!!!

  6. HelenHandbasket

    Just realized that I had a Wells Fargo ARM mortgage that was tied to LIBOR, originated 2002, first adjustment mid-2007. Our payment jumped abot $400 each month, and we paid it for about 6 or 7 months before re-financing with a credit union (into another ARM pegged to a different index and a much lower margin).

    Boo for being touched directly and personally by bankster fraud. Yay for being affluent enough to extricate myself from that situation, and getting it done before the credit markets froze up later that year. It’s chilling to think of how much we would have lost if I’d delayed another month or two.

    1. David

      And congratulations for being given free money by those evil banksters while you had the LIBOR loan, because they were manipulating the rate DOWN!!

      That’s why this scandal is having trouble catching fire despite desperate pushing by the press. Because many homeowners were able to afford their payments and keep their homes due to this manipulation.

      1. skippy

        Poppycock!

        If it was not for the manipulation of basic / key banking determiners, this mess would have never got to the critical mass it has. This is acerbated by VaR / CAD failure rates as the timeline extends and the complete F]ail of the mathematics used to give derivatives validity.

        skippy… Nice try at pleading a case for the mortgage bag holders. High marks for sleaze factor there.

    2. cm

      “[An] ARM mortgage that was tied to LIBOR, originated 2002, first adjustment mid-2007. Our payment jumped abot $400 each month [...] Boo for being touched directly and personally by bankster fraud.”

      Actually, that was the Federal Reserve (belatedly) trying to squash the asset price bubble. You really couldn’t have been unluckier with the timing:

      http://research.stlouisfed.org/fredgraph.png?g=8Jq

      Had you held onto it, you might actually have saved some money (compare 2012 with 2002).

  7. Anon

    As one commenter noted under one of the Economist’s pieces on the Libor mess, the Economist’s own credibility is heavily dented by this.

    Because how could one of the supposedly premier print publications on global economics and finance not know, or even suspect, that Libor manipulation was happening? And only inform its readers of it at about the same time as, say, readers of the Daily Mail found out?

    But then CFO Magazine, part of the Economist stable, did once give an award for “excellence” to Enron’s Andy Fastow, so I suppose we shouldn’t be surprised they missed this one, after all:

    http://www.cfo.com/article.cfm/2989389

  8. Illegal country

    “But the intervention would had to have taken place on an interest reset date, and to hurt borrowers, it have had to be higher.”

    If the 6 month LIBOR was manipulated then you may have some unintended consequences:

    -Were borrowers given higher than “market” margins at origination knowing the index was gamed downward?
    -Servicers had known carrying costs on a mbs. If they are able to reduce these costs then profit may have increased if they were able to unwind/foreclose on the loan in the mbs.

    Furthermore, RESPA doesn’t state that a homeowner needs to be negatively affected in order to have a claim. First American v. Edwards.

  9. arby

    I heard a comment from the Mayor of Stockton – now in bankruptcy Chapter 9 process – with regard to interest rate payments on municipal debt. Due to swaps on variable debt entered into for waterfront improvement borrowing in 2005 and 2006, Stockton’s payments to service that debt have gone up over 600%! Would municipalities have a claim here?

    1. David

      Yes it’s those who were long LIBOR based loans, like munis, who would have a civil case.

      Homeowners owing a mortgage were effectively short and were benefitting. They won’t pay the money back though, they’ll just be quiet as will I!

  10. mac

    You can diddle with all the figures and such as much as you like,but… the bottom line is that Bankers and other business folks who are honest are not expected to lie. Some really severe penalty involving jails, hard labor and the like should be meted out.

  11. Schofield

    And when you go down Memory Lane can you remember the Neo-Conservatives ( Neo-Liberals ) telling us that things would always come out best for the common good if you let markets work without government interference?

  12. Jim A.

    Keep in mind that if you got ANY kind of LIBOR indexed loan when LIBOR was artifically low, you can argue that the spread was artificially wided by by the “fake LIBOR.” Which for a Mortgage could mean years of higher payments once LIBOR becomes honest.

  13. Chauncey Gardiner

    In what I view as a systemically related case, a U.S. District Court judge today ruled that Bank of America, but not its executives, must face a class action lawsuit claiming it concealed its use of an electronic registry system in the mortgage fraud and robosigning scandals: http://www.courthousenews.com/2012/07/12/48326.htm

    IMO we must pierce the corporate veil.

  14. C

    Given that there are indications out of Europe that this manipulation went on for more than 4 years this number should rise.

Comments are closed.