Big Banks, Big Problems, Big Fines

UBS is paying a fine of $1.5 billion. That’s a lot of money.

As the derivatives market grew in the last decade, a number of banks used their role in the rate-setting process to artificially raise or lower rates. They were able to make bets on LIBOR, and then help set LIBOR. They were like big-league sports players betting for or against their own team.

When I say that the derivatives market grew, I mean it really grew. LIBOR is now a benchmark for almost $350 trillion in financial products. A misstatement of just .01 percent means a $35 billion change in payments. The stakes are huge. It’s no surprise that during the financial crisis LIBOR manipulation was an open secret.

When the authorities calculate LIBOR, a select group of big banks are supposed to submit the actual interest rates that they pay to borrow from other banks. But since the banks are able to make multi-trillion dollar bets for their own books, their incentives to game the system are too big to pass up. At UBS, at least 45 bank employees were involved in the scam, and another 70 were included in open chats and messages where rate manipulation was discussed. Some traders set up payment systems to encourage others to cooperate with the scheme—up to $100,000 per year.

But once the con was made public, a host of borrowers—mortgagees, municipalities, corporations—noted that the rate manipulation cost them billions, while the banks brought in billions. The litigation costs, reputational costs, and fines are now expected to depress bank earnings for years.

When athletes bet on their own performance, they’re banned from the sport for life. Compared to being cut out the money markets, $1.5 billion may turn out to be cheap at the price.

Douglas R. Tengdin, CFA
Chief Investment Officer
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