The New York Times reported on July 11, 2012, that Baltimore has been leading a battle in Manhattan federal court against the banks that determine the interest rate, the London interbank offered rate, or LIBOR, which serves as a benchmark for global borrowing and stands at the center of the latest banking scandal. According to the article, cities, states and municipal agencies nationwide, including Massachusetts, Nassau County on Long Island, and California’s public pension system, are looking at whether they suffered similar losses and are weighing legal action.
Dozens of lawsuits filed by municipalities, pension funds and hedge funds have been consolidated into a few related cases against more than a dozen banks that are involved in setting LIBOR each day, including Bank of America, JPMorgan Chase, Deutsche Bank and Barclays. Last month, Barclays admitted to regulators that it tried to manipulate LIBOR before and during the financial crisis in 2008, and paid $450 million to settle the charges. It said other banks were doing the same, but none of them have been accused of wrongdoing.
LIBOR, a measure of how much banks must pay to borrow money from one another in the short term, is set through a daily poll of the banks.
The rate influences what consumers, businesses and investors pay on a wide range of financial contracts, as varied as mortgages and interest rate swaps. Barclays has said it and other banks understated the rate during the financial crisis to make themselves look healthier to the public, rather than to make more money from clients.
The New York Times said that as regulators and lawmakers in Washington and Europe assess the depth of the LIBOR abuse and the failure to address it, economists and analysts are already predicting it could be one of the most expensive scandals to hit Wall Street since the financial crisis.
A separate complaint filed in 2010 by the investment firm Charles Schwab asserts that some of its mutual funds, including popular ones like the Schwab Total Bond Market Fund, lost money on similar investments.
The complaints being voiced by municipalities are mostly related to their use of a popular financial contract known as an interest rate swap. States and cities generally enter into these swaps with specific banks so that they can borrow money in the bond market. They pay bondholders based on a floating interest rate — like an adjustable-rate mortgage — but end up paying their bankers a fixed rate through a swap. If LIBOR is artificially lowered, the municipality is stuck paying the same fixed rate, but it receives a smaller variable payment from its bank.
