The fallout from the manipulation of the London interbank offered rate, or Libor, has already cost banks $2.5 billion in penalties, not to mention loss of reputation.
But that sum pales in comparison to payouts that will come from private lawsuits. Any finding of liability could be compounded because of the potential for any award to be tripled under the antitrust laws.
The latest salvo comes from the mortgage finance company Freddie Mac, which has filed a lawsuit in the Federal District Court in Alexandria, Va. It asserts that the company was harmed by collusive activity among the banks that lowered the benchmark interest rate. And where Freddie Mac goes, Fannie Mae, its larger sibling, usually follows, so we can expect it to file a suit seeking damages from Libor manipulation.
Lawsuits by Freddie and Fannie would not come as a shock to anyone. A memorandum released by the inspector general of the Federal Housing Finance Agency, the overseer of the two mortgage-finance giants, recommend pursuing claims against the banks for what it estimated to be more than $3 billion in damages from the Libor manipulation.
The three regulatory settlements to date - with Barclays, UBS and the Royal Bank of Scotland â€" provide much of the evidence Freddie Mac relies on in its complaint. Among the documents now public is a litany of e-mails demonstrating just how the banks worked to lower their Libor submissions to benefit their trading positions and make themselves appear stronger during the height of the financial crisis.
Normally, one would not expect that collusion would result in lower, rather than higher, prices. But in the world of finance, lower interest rates can be just as lucrative as higher ones, because it is all a matter of which side of the transactions one is on.
In its complaint, Freddie Mac points out two ways that the artificially lower rates cost it money. First, the company hedged is mortgage positions by buying swaps on the fixed-rate mortgages it held so that it received floating-rate payments. When Libor was pushed down by the banks, Freddie Mac received lower payments from the swaps.
The company also bought the swaps from a number of banks that participated in setting Libor. That has led the firm to include claims for breach of contract, as Freddie asserts that any manipulation violated the terms of the agreements to receive payments.
In addition, Freddie Mac held a large portfolio of mortgage-backed securities with floating interest rates. The lower the rate, the less it received in interest. Homeowners may have benefited from the manipulation in Libor by paying less interest on their mortgages, but Freddie Mac received less income on these financial instruments.
Banks involved with the scandal also face legal action from other plaintiffs. A raft of class-action lawsuits have been filed by a number of parties, including states and local governments that issued bonds and bought interest rate swaps. The cases have been consolidated in the Federal District Court in Manhattan for pretrial proceedings.
The banks have sought to dismiss the claims, arguing that the various plaintiffs cannot show that they were directly harmed by any antitrust violation, if one even occurred. In a brief filed in the case, the banks assert that if merely having economic exposure to the dollar-based Libor, or USD Libor, is enough to be part of suit, then “there is no limit to potential plaintiffs, because anyone, with respect to any transaction, might choose to reference USD Libor.â€
Unlike some class-action plaintiffs, Freddie Mac looks to be in a stronger position to survive a motion to dismiss on these grounds. The company dealt directly with many of the banks accused of manipulating Libor by arranging for swaps, including Barclays, UBS and the Royal Bank of Scotland, all of which admitted to violations. The success of its trading in mortgage securities and hedging its risk was usually tied into Libor, the most important benchmark rate for mortgages.
Freddie Mac has taken an even more aggressive position in its lawsuit by naming the British Bankers Association as a defendant. The association was responsible for collecting the data from banks and then issuing the Libor benchmark, marketing it as a valuable tool for setting interest rates across a number of currencies.
It is not clear whether the claim against the association can survive a preliminary motion to dismiss, however. Freddie Mac claims that the organization was aware of the manipulation by the banks but did nothing to stop it. But the fact that one is aware of misconduct by others, and even that their services are being used, is usually not enough to show participation in a conspiracy.
There is also the issue of whether a United States court has jurisdiction over the British Bankers Association. While the banks have global operations and extensive dealings with the United States, the banking association operates primarily in London, and there may not be sufficient contacts with the United States to allow it to be brought into the case. Of course, that will be decided at an early stage when the association does its best to get out of the case.
For the banks, Freddie Mac is the type of plaintiff that can be expected put up a tough fight because, now that it is controlled by the federal government, the real beneficiaries of its lawsuit are taxpayers. Add to that the prospect of a similar claim by Fannie Mae, and the banks involved in Libor manipulation will be dealing with this issue for quite a while.
Freddie Mac v Bank of America LIBOR Complaint March 2013
Libor-Based Antitrust Class Action Dismissal Brief by DealBook
