Libor manipulation suit could open the floodgates

The news that the US Federal Deposit Insurance Corporation (FDIC) is suing European banks in London for manipulating Libor should worry central bankers everywhere.

It’s all hush-hush, with details coming from reports in newspapers, rather than made public officially. The Financial Times reported that the FDIC is suing Barclays, Deutsche Bank, Lloyds Banking Group, Royal Bank of Scotland, Rabobank and UBS, as well as the British Bankers’ Association, accusing them of fraudulent misrepresentation.

Lloyds said it doesn’t believe the claim has any merit, while the others did not comment, according to the report.

The FDIC alleges that the banks submitted artificially low estimates for interest rates in the Libor rate-setting process between the financial crisis of 2007-2009, to make themselves look more creditworthy than they were. This process has become known as “lowballing” Libor.

Documents seen by the Financial Times show that the FDIC is suing on behalf of 39 failed American banks which “suffered loss as a result” of the European banks’ lowballing of Libor, because they relied on the rate to calculate interest or enter into derivative transactions.

The FDIC argues that if Libor had not been manipulated lower, these banks would have made greater returns on their Libor-linked instruments, such as mortgages and other loans, as well as swaps and other derivatives.

This suit is interesting not only because it pits American banks against European ones, or rather an independent US agency against European financial services companies. More interesting is the fact that if successful, it could open the floodgates for similar cases, not just from banks, but from other entities as well.

It is also one of the rare occasions in which the victims of low interest rates come to light. The “accepted” wisdom is that low interest rates are good for everybody: they keep mortgage rates low, so people can buy more houses (think buy-to-let landlords), and they keep the cost of other types of loan down (think new car purchases, etc.).

Low interest rates even help businesses get cheaper loans. Some of these businesses use these loans to buy back shares and thus flatter their EPS figures, but hey, that’s just financial prowess, right? Why use your hard-earned cash when interest rates are so low it doesn’t make sense not to borrow?

But the tide is turning. The victims of low interest rates — the most prominent seems to be the FDIC — are beginning to ask for justice.

And why stop at Libor? Why not look at who else is manipulating interest rates? And from here on, how long before people turn towards central banks and accuse them of misselling? Perhaps some of them would have never taken the huge mortgages they have taken on, had interest rates been higher.

We should all watch the FDIC versus European banks suit closely. But central banks ought to give it some extra attention.

Here are some important dates next week:

— Monday

The UK set to publish two position papers about Brexit issues

— Wednesday

Eurozone manufacturing, services PMI

Eurozone consumer confidence

— Friday

ECB President Mario Draghi set to speak at Jackson Hole meeting