Did Bank Insiders Manipulate Libor Rate Causing Problems all over USA?
By MERRILL GOOZNER, The Fiscal Times
July 23, 2012
It seemed like a good idea at the time.In the two decades before the 2008 financial collapse, the investment banking industry sidled up to state and local finance officials with an offer they couldnt refuse. Instead of issuing plain vanilla 30-year fixed-rate bonds to build roads, schools and parking garages, why not sell variable rate bonds at lower rates and buy a swap that would fix the total payment at something lower than what theyd pay in the fixed-rate market?
It was supposed to be win-win. The government agency got a slightly lower rate, while the investment bank earned fees. If the variable bonds rate rose above the fixed rate target the scenario that government finance officials feared most the swap counterparty (the banks often off-loaded the instruments to speculators) paid off the government agency. If the variable bond rate went down, the swap payments moved in the other direction: from taxpayers to speculators. Either way, the governments total cost was supposed to stay fixed.
There was a slight problem with the formula, though one that would cause tremendous grief later on. Changes in the variable rate bonds were almost always tied to an index of actual municipal bond transactions compiled by the U.S.-based Securities Industry and Financial Markets Association (SIFMA). Changes in the swaps, on the other hand, were tied to the London Interbank Offered Rate (Libor), which is set by the British Bankers Association based on reported rates from global banks. If Libor moved lower at a faster pace than SIFMA, government agencies hedge would come up short.
By the late 1990s, the muni swap bond deals started coming in as many permutations as Wall Street could imagine. The city of Oakland, Calif., for instance, sold a $187.5 million variable rate revenue bond to investors. How did they do it? Earlier this month Oakland became the first city in the nation to demand cancellation of a swap, or the company that sold them the swaps in the first place Goldman Sachs would be banned from doing business with the city.
To eliminate the risk of rising rates, Goldman came up with an exceedingly complex structure. The city paid Goldman a fixed rate that was slightly lower than what was then available in the market. It simultaneously purchased a variable swap that required Goldman to pay off the citys variable rate bond, plus make a payment to the city that was tied to Libor. If Libor went down, so did the citys payment.
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