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.