Oh I don't know how would *you* illustrate a post about Libor manipulation? Photographer: Chris Ratcliffe/Bloomberg
Oh I don't know how would *you* illustrate a post about Libor manipulation? Photographer: Chris Ratcliffe/Bloomberg

By this point regulators have brought a bunch of cases against banks and people who manipulated the London interbank offered rate and have learned some lessons from those cases. Perhaps the most important lesson is that these cases are sort of boring, but they are enlivened by just bushels of dumb e-mails and instant messages.

Everyone just pays attention to the dumb e-mails and IMs. So today the U.S. Department of Justice, U.S. Commodity Futures Trading Commission, and U.K. Financial Conduct Authority brought Libor charges against ICAP Plc, an interdealer broker, and some of its employees, and the CFTC was smart enough to put all the dumb stuff in one place, a document labeled "Examples of Misconduct From Written Communications." They're fun. In my book the two champions are this one:

And this one:*

By the way, that "Lord Bailiff" is not a one-off. "Cash Broker 1 referred to himself and was called by others by such monikers as 'Mr. LIBOR,' 'Lord LIBOR,' 'Lord Bailiff' and 'M’Lord.' " Of course he did.

Beyond the general stupidity, the case is weirdly fascinating; it's like a Keynesian beauty contest in reverse. The story is that Tom Hayes was a swaps trader at UBS who made a lot of money trading Yen Libor swaps, and funneled a certain amount of that money into commissions paid to his interdealer swaps brokers at ICAP, Daniel Wilkinson and Darrell Read. One way that Hayes made a lot of money was by convincing Libor submitters at UBS and elsewhere to submit the Libors he wanted.

(Background: Libor for any currency and tenor is, or was anyway, set by the British Bankers Association polling a bunch of Libor submitters -- basically, cash traders at banks responsible for short-term borrowing -- and asking them "what rate do you pay to borrow [currency] for [tenor]?" The BBA would throw away the top and bottom few submissions and average the rest. So to move Libor you'd want to get at least a couple of banks to join you to actually push the trimmed average up.)

Hayes convinced Libor submitters at UBS to submit the Libors he wanted in the usual ways: rank, friendship, cajoling, bribes and general sitting-next-to-them. He convinced Libor submitters at other banks to submit the Libors he wanted through ICAP. He'd ask Wilkinson and Read to push Libor up or down, and since he was a big client, they tried to oblige.

The way they obliged was mainly by asking Colin Goodman, aka Cash Broker 1, aka Mr. LIBOR, aka Lord LIBOR, aka Lord Bailiff, aka M'Lord, to adjust his "suggested Libors." From the CFTC complaint:**

Cash Broker 1 routinely disseminated his Yen Run Thrus every morning at approximately 7:00a.m. London time, well before the BBA's 11:00 a.m. Yen LIBOR submission deadline. The Run Thrus contained the following information: (1) a column stating where rates (prices) in basis points for Yen cash trades, for all tenors, were observed the previous trading day, broken down by Japanese and non-Japanese financial institutions; (2) a column stating the spread of rates for Yen cash trades for all tenors that were observed as of the market opening in London and late afternoon Tokyo, broken down by Japanese and non-Japanese financial institutions; and (3) a column titled "Suggested LIBORs," which contained Cash Broker 1 's suggestions as to where the published Yen LIBOR fixing for each tenor between one month and one year would set that day.

The gist of the CFTC order, FCA final notice, and DOJ complaint is that these suggested Libors were fraudulent.

How could they be fraudulent? Well, they would be fraudulent if they differed from Goodman's honest prediction of where Libor would set. What would be the harm of the fraud? Well, it would move Libor from Goodman's honest prediction of where Libor would set towards his dishonest suggested Libor.

See the problem?

The problem is that since Goodman's suggested Libors were influential -- since he was Lord Libor -- and since Libor is basically a made-up number representing banks' guesses at what rate they'd pay to borrow in markets where they don't actually borrow, his "false" predictions often ended up being more correct than his honest predictions. Because, y'know, they were self-fulfilling.*** From the DOJ complaint:

On or about November 29, 2007, in an email exchange with the subject line "libors," READ told GOODMAN, "Welcome back M'Lord' Tom has been like a little lost sheep without you!!" READ continued , " I would very much like to see 1m up above 1.00% today . . . . Let me know your thoughts mate and do your best for us!! " GOODMAN responded , "ill go 1.01 for you . . . . Im really comfortable with below 1 pct." As promised, in his "run thru" email that day, GOODMAN disseminated his 1-month "SUGGESTED LIBORS" rate at 1.01% .

Sic throughout of course. Japanese Yen 1-month Libor fixed at 1.00375 percent that day. His honest prediction -- below 1 percent -- was wrong. Because he made it wrong. His fraudulent prediction -- 1.01 percent -- was closer to being right.**** Because he made it right.

The exaggerated schematic is:

  • Banks, in the absence of actual borrowing rates, blindly followed Lord Libor's predicted Libors.
  • Therefore, any Libor that Lord Libor predicted would become the actual Libor.
  • Therefore, Lord Libor's predictions, whatever they were, were ipso facto correct.*****
  • And he knew it.
  • Therefore it was impossible for him to commit fraud in these predictions.

Oh, I mean he did it anyway: The e-mails are just chock full of fraud. Fraud fraud fraud fraud fraud. But it's a weird sort of fraud: The dishonesty is plain enough in intention, yet metaphysically impossible. If your predictions just always come true how can they be dishonest?

The CFTC has a theory, incidentally, but it's nuts:

In providing this market information [the suggested Libors], interdealer brokers are implicitly representing that such market information reflects their third-party unbiased assessment of borrowing costs and market pricing based on objective, observable data, some of which they uniquely possessed.

"Implicitly," here, means "not." When Viscount Libor sent an e-mail of suggested Libors, what he was doing was suggesting some Libors. You can tell because the heading was "SUGGESTED LIBORS." He would have been very surprised to hear that he was representing that those suggested Libors reflected his third-party unbiased assessment of borrowing costs and market pricing based on objective, observable data. You can tell from the rest of his e-mails.

This is not unique to ICAP, though it's particularly acute here. The thing about Libor is that it was all about making up numbers: At the peak of the Libor scandal, banks didn't really borrow unsecured in most of the currencies and tenors in which they submitted Libors, so every number was made up. Nobody submitted a Libor that represented what it was supposed to represent -- their own cost of unsecured borrowing. The only question is one of intent: Were they trying to get Libor right, whatever that meant, or were they trying to fool people and make money on swaps? The behavior -- making up a number -- was the same either way.

ICAP is the second derivative of that: They weren't making up numbers, with evil in their hearts or otherwise. They were suggesting numbers for other people to make up.

Like the banks, ICAP more or less had to settle -- for $87ish million all in, a chunky sum for a small broker -- because the e-mails are so obviously terrible. These guys sure thought they were committing fraud, so it's hard for ICAP to fight. The three traders, who supposedly "face as long as 30 years in prison if convicted of the most serious charges," have rather more incentive to fight.

* From the CFTC complaint, but weirdly not in the highlights reel. Another stellar one from the complaint:

NOTHING LIKE AN ALL-CAPS E-MAIL SAYING YOU SHOULD STOP DOING CRIMINAL STUFF OVER E-MAIL HUH?

** Just before that:

In addition to brokering transactions, as part of their client services, interdealer brokers, including ICAP, frequently provide clients with their views and advice on market pricing and trends, often called "market color." Clients, including LIBOR submitters and interest rate derivatives traders at panel banks, rely on brokers for such information. Because brokers speak to multiple clients at different financial institutions and share internally the information learned from clients, they have particular market insight about cash market prices and trends in otherwise opaque markets, offering an important price discovery function. In providing this market information, interdealer brokers are implicitly representing that such market information reflects their third-party unbiased assessment of borrowing costs and market pricing based on objective, observable data, some of which they uniquely possessed.

During the relevant period, certain interdealer brokers, including ICAP brokers, provided, and still provide, predictions or suggestions of where they believe key benchmark interest rates, such as LIBOR, would fix on specific days. Interdealer brokers, including ICAP brokers, also at times shared with some panel banks the intended LIBOR submissions of other panel banks.

During the relevant period, a number of ICAP brokers and brokers at other brokering firms circulated via email or by telephone each morning daily Run Thrus of the rates they expected to be published for LIBOR in various currencies and tenors, as well as other pricing information.

*** As the DOJ complaint succinctly-ish puts it, nicely capturing the circularity:

From at least in or about July 2006 through at least in or about September 2010, READ, WILKINSON, and GOODMAN, together with Hayes, and others known and unknown, intending to influence and manipulate the benchmark interest rates to which the profitability of Hayes's derivatives trades were tied, engaged in a scheme to defraud Hayes's counterparties of money and property by disseminating false and fraudulent statements regarding predicted Yen LIBORs to Yen LIBOR Contributor Panel banks which, in turn, sometimes relied on the misinformation when making their own respective Yen LIBOR submissions to the BBA for inclusion in the published fix calculation, and further by directly and indirectly causing altered Yen LIBOR submissions to the BBA.

The CFTC is more emphatic about how much banks relied on the brokers:

During the 2007-2009 financial crisis, LIBOR submitters became increasingly reliant on interdealer brokers for their market information, including specific information about the level at which other panel banks intended to submit LIBORs, and the brokers' suggested LIBORs. This reliance was due to limited interbank lending occurring upon which submitters could base their LIBOR submissions. Some panel banks believed at times during the financial crisis that such market information provided by ICAP and other interdealer brokers was possibly the only meaningful market information available to assess their ability to borrow funds in the interbank markets.

**** I guess that's debatable, maybe his honest prediction in his heart of hearts was like .99875. For what it's worth 1-month Yen Libor had fixed at 0.65625 percent the previous day, and fixed at .99625 percent the next day.

There are other examples in the complaints; e.g. on August 9, 2007, Goodman sent out a run-thru with a 6-month suggested Libor of 0.93 percent. Later Hayes asked Read to ask him to move it higher. Goodman obliged, sending out an email titled "REVISED LIBORS" with a 6-month rate of 0.96 percent. The fixing was 0.9525 percent. Again, the dishonest prediction was more accurate than the honest one.

***** Not quite true; the DOJ complaint quotes an e-mail from Read to Hayes saying "like Colin said to me last night, he can try and tweak it by a point or 2 when its flying but if he marks too far from the truth the banks tend to ignore him."