Who are the victims of the LIBOR scandal?

The following is a blog entry that originally featured on the Cass Finance Blog. Anthony Neuberger is Professor of Finance at Cass Business School.

Massive fines have been paid by investment banks to regulators - $1500m by UBS, $460m by Barclays, up to twenty major banks under investigation or named in court cases - but who and what the victims of the LIBOR scandal were is still not clear. Are the victims the millions of ordinary householders across the world on floating rate mortgages linked directly or indirectly to LIBOR? Are they the armies of pensioners living off the interest from their deposits?

As more details are emerging, some things are becoming clearer. The manipulation was not confined to any one bank or market. Regulators in US, UK, Canada, Japan and the EU are all involved. As cases hit the law courts more information becomes public. Last December the US Department of Justice filed charges against two former UBS traders, Tom Hayes and Roger Darrin, accusing them of manipulating Japanese Yen LIBOR. The complaint casts light on how the DoJ believe the manipulation happened and how large it was.

To me the striking feature of the charges is the size of the manipulation. UBS is one of sixteen banks which submits LIBOR estimates. LIBOR is computed by taking the average of the middle eight quotes. The scope of any one bank to move LIBOR is therefore limited. The DoJ complaint suggests that the manipulation (which happened on many days) typically amounted to one eighth or one sixteenth of a basis point. To put this in perspective, if you borrow $1 million and pay one sixteenth of a basis point extra in interest, that costs you $6.25/year extra. Theft is theft, but stories of banks' dishonesty leading to pensioners being foreclosed can be treated with a pinch of salt.

The counterpart to the small absolute size of the manipulation is the very large principal amounts at stake. The reason it would be worth moving LIBOR by as little as a fraction of a basis point is that UBS apparently had positions that might be worth as much as $2 million for each basis point. This would correspond to UBS having in effect a principal position of $80 billion tied to the LIBOR fix on that one day. That position looks huge. The complaint says nothing about the overall strategy being pursued by UBS. But a naked bet on short term Japanese interest rates of this magnitude looks unbelievable. Even if one can move the goal posts a bit, the underlying uncertainties of short term interest rates make such a large bet look very unattractive. It seems much more likely that the position was some sort of spread trade with a comparable offsetting position in another rate - maybe the six month rate, or 3 month LIBOR on a different date.

There is no doubt a lot more to come out about what was really happening in the LIBOR scandal and it is foolish to try to draw firm conclusions on the basis of limited evidence, but at least a possible hypothesis is starting to emerge. The principal counterparties to the large spread trades are likely to be other banks, and hedge funds. Maybe the main victims then were largely other banks and financial institutions. Not a victimless crime - there is no such thing - but rather like fouls committed in professional sport. It's wrong. We should have some sympathy no doubt for the banks that did not cheat, and for the banks and hedge funds who were not on the LIBOR panel and who were speculating in what has turned out to be a rigged market. But at the moment this does not look like a gigantic fraud perpetrated by Wall Street on Main Street.