Finding a Remedy to a $300 Trillion Problem

Analysts devise ways to calculate how rate rigging hurt investors | “The facts are pretty clear on the plaintiffs’ side”

Keri Geiger, with David McLaughlin and Andrew Harris

Paula Ramada, who earned a doctorate in economics at the Massachusetts Institute of Technology, says she knows how to calculate how much an investor lost when banks allegedly rigged benchmark interest rates. Now she just needs a team of analysts — and a client to fund the work.

Ramada is among a growing number of mathematicians and analysts trying to tackle a key question to emerge from the Libor scandal: If banks manipulated rates tied to $300 trillion in instruments ranging from mortgages to student loans, how much do the firms owe investors? With lawsuits wending through courts, the damage payments could climb into the billions of dollars.

For decades, a panel of global banks helped set the London interbank offered rate each day by estimating the premium they would pay to borrow from other firms. Watchdogs are examining whether employees manipulated submissions to boost trading profits or downplayed their banks’ mounting funding costs during the financial crisis. Barclays, UBS, and the Royal Bank of Scotland Group agreed within the past 12 months to pay a combined $2.6 billion to resolve U.S. and European regulators’ claims that traders gamed the system. At least a dozen other institutions say they are still facing probes.

Although the regulatory actions provide evidence that the banks misbehaved, investors must show in court how they were hurt, says Samuel Buell, a law professor at Duke University and a former federal prosecutor. “The facts are pretty clear on the plaintiffs’ side, but it’s still an issue of proving damages,” he says.

Banks generally haven’t disclosed any estimates of their potential exposure to Libor-related sanctions or lawsuits. Analysts’ estimates vary. In a research note last July, Morgan Stanley said legal costs for individual banks may range from $59 million to more than $1 billion. In another report that month, Macquarie Group said investors may have lost as much as $176 billion and that banks might ultimately be forced to pay about half that amount.

Ramada and her team of researchers at London Economics, a U.K. consulting firm, propose a two-step approach. They look for divergences between Libor and other benchmark interest rates that track the cost of unsecured funding to banks, such as the Federal Reserve’s Eurodollar deposit rate, as well as instruments linked to the banks’ credit risks, such as credit-default swaps. The second step is to recalculate payments on specific contracts. For that, investors will need documents from their trades. “The problem comes when a company doesn’t have accurate records on each and every interest rate product,” Ramada says.

Libor rates were probably 25 basis points to 35 basis points (a basis point is one hundredth of a percentage point) lower than they should have been from late 2007 through early 2009, according to a preliminary estimate from Marc Vellrath, chief executive officer of economic consulting firm Finance Scholars Group. His company, like Ramada’s, is conferring with plaintiffs’ lawyers who want to quantify their damages. The methodologies for determining damages may become a battleground, with opponents arguing over computer modeling, a decade of market prices, and the fine print on derivatives-trading agreements — if they still exist.

Another complication for investors seeking damages: Not every investment was hurt by Libor manipulation. A plaintiff who shows financial losses on one part of his portfolio might have benefited on other positions, reducing total losses, according to C. Bailey King Jr., a lawyer at Smith Moore Leatherwood in Charlotte. “This could be used as a defense tactic for the defendant banks,” he says.

The bottom line Anyone hoping to recover Libor-rigging damages faces tricky calculations and will need thorough documentation.


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