Putting The Lie In LIBOR

My review of The Spider Network by David Enrich

The Spider Network transforms a monochrome character into colorful hero. Tom Hayes prefers hot chocolate to slamming down bottles at nightclubs. He prefers watching The Blind Side to all expenses paid bacchanals in Monaco. That’s when he’s not making $100M a year for UBS and taking up 40% of the Tokyo derivatives market.

Tom spilled his guts to Enrich about the LIBOR fixing scandal. A WSJ feature writer, Enrich read the entrails and found that Tom failed to follow the inside rules of the club. Earlier on a member told Tom: never trust a broker. Tom’s failure to pick up social cues, aided by his mild autism, allowed the club to make him the sacrificial offering to atone for their LIBOR sins.

The London Interbank Offered Rate (LIBOR) is an average of rates that leading banks would charge to lend to each other. At 10 AM in London, a clerk from each of these leaders submits a number. The number is judgement based, not transactional based. A trade association collected the nue and published the daily rate. This rate became benchmark used in countless derivative contracts and consumer loans during the credit gorging aughts. LIBOR underpinned $350 trillion in debt contracts, trillion with a T. The light touch London regulatory regime refused to regulate the judgment rate.

If the rate moved 0.01% in the right direction, it could generate millions in propriety trading profits. By most accounts, traders manipulated LIBOR as far back as 1991. As traders would say: want to move LIBOR, just give the clerk a mars bar.

Universal banks pressured proprietary traders like Tom to take more risks to generate even larger profits. Consumers devoured debt: mortgages, credit cards, and car loans. Instead of a set rate like a traditional loan, many of these loans used the fluctuating LIBOR. Financially linked, these loans had little relation to LIBOR, economically. Joe Sixpack buying a McMansion in Las Vegas or an Escalade in south Florida has nothing to do with London banks theoretically lending each other money.

Municipalities bought credit derivatives to protect against fluctuations in commodity or interest rate markets. Rural municipalities find their tax revenues dominated by a single industry — energy or agriculture. Bankers sold them products to hedge swings in the market. Municipalities had to hedge tax revenue risk because municipalities prefer issuing revenue backed bonds to raising taxes. Muni bond’s tax free interest status allows them to borrow at below market rates. As municipalities became major borrowers, they needed to protect against interest rate risks. As underwriters for the municipalities’ debt, banks needed to protect their assets by selling them more product. The banks bilked thier lightly regulated rubes.

LIBOR comes in thirty-five different flavors. There are seven different borrowing periods in five different currencies. The rates did not move together as one might expect because most were fixed.

The LIBOR fix became clear during the 2008 financial crisis. As the old saw goes: when the tide goes out, that’s when you see who is swimming naked. Markets dropped and bounced like a dead cat. Diverse assets converged. Banks stopped lending. But LIBOR stayed steady. While traders manipulated the number, borrowers benefited from a low and steady number. The LIBOR market stayed open, Tom had his best year ever.

True, municipalities should have been better compensated for the interest rate fluctuations. But blaming Tom for municipal losses is like blaming a poppy farmer for using toxic herbicides instead of going after the heroin dealers and kingpins.

Enrich presents Tom as a round protagonist and not without blame. Tom did more than offer the clerk a mars bar. He set up switch trades that had no business reason except to curry favor with the LIBOR setters. In order to set these trades up, Tom needed another trader and a broker. Tom used three different brokers to spread his influence. Theoretically all these parties are supervised and thier firms have compliance departments. But the switch trades worked with no questions. In the end, six other traders and brokers faced charges in connection to Tom’s fixing. A London jury found them not guilty.

Tom’s daily mars bars and desperate switch trades were all on record. Banks record employees’ email, landlines, and instant messages. Tom could have used video conferences and cell phones, but he did not think he was doing anything wrong. Tom was blatant.

Like any sympathetic criminal, Tom had a rough childhood. His mother did not pay attention to him. His dad split. His family had money problems. He was socially award. He bombed an interview with an Oxford admissions officer because Tom could not make eye contact.

His social problems never went away. He succeeded at work because of his math skills, market grasp, and work ethic. But he did not fit in the club. The boys in the club called him Tommy chocolate, Rain Man and Kid Asperger. Doctors did not diagnose Tom as mildly autistic until he stood trial. His trial is the other scandal Enrich covers.

The LIBOR scandal symbolized finance’s dysfunctional greed. Poor regulation mixed with increasing performance demands led to fraud. The real victims of the LIBOR scandal were the banks in the club. Reforms made fixing almost impossible and competitor benchmarks emerged. As wards of the state, the bank faced mounting threats of litigation and regulatory fines for all their excesses of the aughts. Coming clean with the LIBOR fix distracted from other issues. To assign guilt, bank brass came down on the trading floor and the trading floor offered up Tom. Never trust a broker.

Thanks for Reading!

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