Was Geithner ‘forceful’ on Libor?
“Exceptional.” “Very forceful.” “Early.” Those are the words used by Treasury Secretary Tim Geithner recently to describe what he did in the spring of 2008 to address problems with the key interest rate known as Libor. During Geithner’s congressional testimony this week, New York Senator Charles Schumer called Geithner “proactive.” Not to be outdone, White House Press Secretary Jay Carney chimed in after Geithner’s testimony, calling what Geithner did “aggressive.” The key piece of what he did, of course, was to send a memo dated June 1, 2008 to Bank of England Governor Mervyn King suggesting changes to improve the credibility of Libor.
Plenty of commentators, and especially Republicans, have given Geithner a hard time about his lack of other action. That’s not entirely fair because Geithner didn’t completely ignore the Libor problem; in addition to his memo, he also brought it up to the President’s Working Group on Financial Markets and to the Treasury. But at the same time, the lavish praise is hard to understand. How can it have been exceptional, forceful, early or aggressive for Geithner to have sent a memo across the Atlantic, when the press and the financial research community had already written not just about the problem with Libor but also about its potentially far-reaching consequences?
Consider that six weeks before Geithner’s memo, the Wall Street Journal’s Carrick Mollenkamp wrote an April 16, 2008 story entitled “Bankers Cast Doubt on Key Rate Amid Crisis.” The piece noted that Libor – which is supposed to be the average interest rate at which banks make short-term loans to each other and which serves as a basis for trillions of dollars in other loans – had become such a fixture in credit markets that many people trusted it implicitly. Mollenkamp quoted a mortgage banker who said he depended on Libor to tell him how much he owed his bank. Concerns about Libor’s reliability are “actually kind of frightening if you really sit and think about it,” the banker told Mollenkamp. On May 29, the Journal followed up with another, even more detailed analysis, which crunched the numbers to show just how much the banks might be understating Libor.
Even before the initial Journal piece appeared, on April 10, 2008, a research analyst at Citigroup named Scott Peng wrote a report headlined, “Special Topic: Is LIBOR broken?” Peng concluded that Libor could understate actual interbank lending costs by 20 to 30 basis points. Ironically enough, he based his evidence in part on the fact that the Fed itself was providing short-term loans to banks at a higher rate than Libor. Not incidentally, Peng (whom Mollenkamp cited in his story) wrote the following: “LIBOR touches everyone from the largest international conglomerate to the smallest borrower in Peoria … the functionality and relevance of LIBOR is of primary importance to the global financial system … if LIBOR, now the most popular floating-rate index in the world, loses credibility because it no longer represents true interbank lending costs, the long-term psychological and economic impacts this could have on the financial market are incalculable.”
And even before that, in March 2008, in another report Mollenkamp cited, two economists at the Bank for International Settlements wrote their own report raising questions about Libor. They said that banks might have an incentive to provide false rates to profit from derivatives transactions, and that although the practice of throwing out the lowest and highest groups of quotes was likely to curb manipulation, Libor rates could still “be manipulated if contributor banks collude or if a sufficient number change their behavior.”
In other words, at the time Geithner wrote his “early” memo, it was already known that there was likely a big problem with Libor, that the problem could affect a wide range of borrowers and that the damage from any manipulation could be, as Peng put it, “incalculable.” If you were inclined to be nice, you might call Geithner’s actions “timely.” But that’s about it.
In fairness, Geithner’s lack of follow-through was hardly unique: The Journal noted in its pieces that the British Bankers Association was aware of the problem, and other regulators and law enforcement people could have read the paper and taken action, too. But as followers of the Libor scandal now know, the New York Fed did have access to what seems to be some unique information. On April 11, 2008, just before the Journal story ran, Barclays basically confessed, telling the Fed: “We know that we’re not posting, um, an honest rate.” That wasn’t in Geithner’s “aggressive” memo; Geithner said in congressional testimony that he wasn’t aware of that specific conversation. Say what you will about JPMorgan CEO Jamie Dimon, but when he found out that he should have known something he says he didn’t know, he didn’t call himself “exceptional.” He said: “We screwed up.”
You could argue that four years later, we’re seeing the results of investigations Geithner helped set in motion. Maybe. You could also argue, and some have, that the failure to do anything earlier is no big deal, and that a memo is all that was called for, if even that. After all, it’s uncertain what the financial impact of any Libor manipulation was. And the very fact that so many people suspected there was a problem means that those involved, from the perpetrators to the regulators, must be innocent. How can you commit a financial crime in plain sight?
The problem with that line of argument is that many financial crimes are committed in plain sight. The casual acceptance of widely known wrongdoing is almost the definition of modern financial malfeasance. Think about the dotcom era research scandal, in which investment bank “analysts” wrote puffy research pieces so that unsuspecting investors would put their savings into inflated stocks. Lots of people were in on the game. Did that make it right? Or think about the housing bubble. An awful lot of people understood that dubious loans were being packaged up and sold as triple-A securities. That was just the way things were done, and so almost no one questioned it. Again, does that make it right? And while it may turn out that the economic impact of any manipulation of Libor was small, that doesn’t change the fact that people cheated. The cost of that, in terms of lost trust, is indeed incalculable.
If you think more broadly about human history, some of the worst abuses have often occurred in the relative open. What is “exceptional” and “aggressive” is to be able to see that what’s happening is wrong, and to do something concrete to stop it. As human history also shows, that’s unfortunately a lot to ask of someone. But let’s save the extravagant praise for when it’s truly been earned.
PHOTO: U.S. Treasury Secretary Timothy Geithner delivers his testimony regarding the annual report of the Financial Stability Oversight Council before the House Financial Services Committee on Capitol Hill in Washington, July 25, 2012. REUTERS/Jonathan Ernst