A long time ago some big banks decided that it would be good to sell interest-rate derivatives.1 To do that they needed an interest rate on which to sell derivatives. Various possibilities presented themselves -- Treasury rates or whatever -- but the interest rates that the banks themselves paid on short-term borrowing had an especially obvious appeal as an index. If you're a bank, that data is readily available to you, you don't have to worry about government-market idiosyncrasies, and it's easier to be hedged if your derivatives (and the floating-rate loans you write to clients) are indexed to your own borrowing costs.
But being like, "we'll exchange you a fixed rate of 7% for a floating rate of 3% over our cost of three- month borrowing" is kind of weird. For one thing, it makes the client nervous: What if the bank has an accident and its cost of borrowing goes way up? (What if the bank lies about its cost of borrowing?) For another thing, it makes interest-rate swaps less fungible and liquid: A swap of JPMorgan-plus-300-basis-points is not easily comparable to a swap of Citi-plus-325, so you can't really close out a position in one by selling the other.
So the banks got together and decided: Let's create a composite of our borrowing costs and all sell swaps against that composite. We're all talking to each other anyway as we go about borrowing from each other, so let's all just write down how much we're paying to borrow, send our costs to a trade association, take a trimmed average, call it the London interbank offered rate, and write all our swaps against Libor. We can even set up a different trade association to make sure that we all have the same documents for our swaps, so that all our swaps work the same and use the same rate that we all more or less agree on.
So they did that, and it was great. I mean, it was, for them. You can complain because Libor has fallen into some disrepute of late, and they can complain because "fallen into disrepute" really means "has racked up some enormous fines for Libor banks," but I don't want to hear it from any of you. U.S. banks -- U.S. banks alone -- made $2.8 billion just last quarter from trading interest rate derivatives. That decision to have a standardized thing that they all agreed on as the basis for those derivatives worked out just plain great for them.
It's a little awkward, I guess, in that all these banks that are supposed to be competing with each other are actually coming together to agree on things like contract terms and benchmark rates, but that is only worth worrying about in a very formal sense. The fact that the banks all get together to agree on this stuff makes the underlying derivative market more liquid and competitive and all that good stuff.
Later some people at those banks decided to lie about their borrowing costs in their Libor submissions, and to encourage their buddies at other banks to lie about their borrowing costs, in order to help their derivatives positions. As you may have heard. That was sort of unfortunate! But it was unfortunate for more or less the reasons that other "market manipulation" or "fraud" would be unfortunate: It made prices wrong, in a way that made money for the bad guys at the expense of innocent victims. That's bad.
But it's not really antitrust bad, is it? Nobody is competing to submit Libor quotes, so messing with someone else's Libor quote doesn't seem like interfering with competition. It's interfering with cooperation. If that cooperation is good, which it probably is, then interfering with it is bad, but not in an antitrust way.
Anyway, that seems to be the American conclusion, which is why the Justice Department, which has gone after Libor manipulators for manipulation and fraud, hasn't really pursued Libor antitrust stuff. It's also why a New York federal judge dismissed an antitrust suit over Libor in March. She said:
As plaintiffs rightly acknowledged at oral argument, the process of setting LIBOR was never intended to be competitive. Rather, it was a cooperative endeavor wherein otherwise- competing banks agreed to submit estimates of their borrowing costs to the BBA each day to facilitate the BBA’s calculation of an interest rate index. Thus, even if we were to credit plaintiffs’ allegations that defendants subverted this cooperative process by conspiring to submit artificial estimates instead of estimates made in good faith, it would not follow that plaintiffs have suffered antitrust injury. Plaintiffs’ injury would have resulted from defendants’ misrepresentation, not from harm to competition.
Europe disagrees! Today the European Commission fined eight banks €1.7 billion "for participating in cartels in the interest rate derivatives industry," which is a little silly.2 Here:
Joaquín Almunia, Commission Vice-President in charge of competition policy, said: “What is shocking about the LIBOR and EURIBOR scandals is not only the manipulation of benchmarks, which is being tackled by financial regulators worldwide, but also the collusion between banks who are supposed to be competing with each other. Today's decision sends a clear message that the Commission is determined to fight and sanction these cartels in the financial sector. Healthy competition and transparency are crucial for financial markets to work properly, at the service of the real economy rather than the interests of a few."
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