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Assessing Libor's impact

State, prosecutors to examine if agencies lostmoney over ratemanipulation scandal

By Steven Syre
Globe Staff / July 12, 2012
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Massachusetts prosecutors will meet with state finance officials next week to examine whether public agencies lost money when a key interest rate used to price loans and credit around the world was manipulated by bankers several years ago.

The meeting is prompted by the growing scandal involving rate-fixing of the one of the world’s most widely used interest benchmarks, the London interbank overnight rate, or Libor as it is known.

“No one can look at this and not be concerned about the potential impact,” said state Treasurer Steven Grossman. “My obligation is to protect the taxpayers’ money.”

However, Grossman said it was “premature” to determine if the state had suffered any actual loss.

Meanwhile, large nonprofit institutions and investment management firms in Massachusetts said Wednesday they were following developments in the unfolding scandal and trying to determine whether they had been affected.

Based on interest charges reported by the world’s major banks, Libor is used to determine lending rates for trillions of dollars of credit, from loans between financial institutions to credit cards and adjustable-rate mortgages.

It is also used to determine rates on financial investments known as interest-rate swaps that many borrowers, including municipalities and government agencies, buy as insurance policies to help manage their debt costs. If Libor was manipulated to artificially low levels, swap holders could have been shortchanged.

One of the banks involved in setting Libor rates, Barclays PLC, last week admitted to regulators that it tried to manipulate the benchmark by reporting false rates before and during the financial crisis. It agreed to pay $450 million to settle charges and said other banks were engaged in the same kind of activity.

“We are currently investigating the serious allegations around the manipulation of the Libor and working diligently to determine what, if any, impact it may have on Massachusetts investments,” Attorney General Martha Coakley said in a statement. “We are also working with other state agencies to determine whether they have suffered any losses as a result.”

Many Massachusetts agencies owned interest-rate swaps during the period when Libor was allegedly manipulated — around 2007 and 2008. State officials are now trying to determine if they were cheated out of insurance payments from those swaps because the banks set Libor artificially low.

“We’re following it, and we’re going to look and see what our legal recourse is,” said Jonathan Davis, the acting general manager of the MBTA, which had entered into a dozen interest-rate swap agreements worth a total of $1.6 billion over five years during the previous decade.

The state Department of Transportation is another active participant in interest-rate swaps; in 2010 alone it entered into swap contracts to cover some $800 million in borrowing. The agency is “actively investigating its portfolio for the purpose of determining if it was underpaid,” a spokeswoman said.

The Massachusetts Water Resources Authority also said it was looking into its longstanding $350 million interest-rate swap agreement to see whether it could have been susceptible to Libor manipulation.

Swaps became popular investment tools during the past decade, offering big borrowers such as state agencies the chance to limit the financial exposure when they borrowed money at adjustable rates, as many did. Borrowers would buy swap contracts from big banks or investment banking firms, typically for the same amounts as they borrowed through variable-rate bonds; the swaps would provide a source of funds to pay higher debt service if interest rates on their bonds rose.

So if the Libor benchmark used to determine the payout from the swaps was manipulated lower, then the holders of those contracts would have received less money. A tiny shift of 0.01 percent on a $100 million contract would change the swap payout by $10,000.

The amounts in question may turn out to be relatively small — if they can be proven at all. But the global market for swaps and other Libor-based investments is huge, exposing the banks accused of manipulation to serious liability.

“A few [hundredths of one percent] times trillions is a lot of money,” said Darrell Duffie, a finance professor at Stanford University. “I’m not saying there’s trillions of dollars subject to litigation, but it’s going to be a big number.”

Many other state and local governments are also investigating whether they lost money from the interest rate manipulation and should sue the big banks at the center of the scandal. The city of Baltimore, which filed a class action lawsuit in New York against 14 banks, alleged rate manipulation damaged its finances.

Meanwhile, the investment firm Charles Schwab Corp. has sued major banks over similar allegations of Libor manipulation. Firms like Schwab sometimes invest in interest-rate swaps, especially for money market funds. Fidelity Investments in Boston said Wednesday it had been following developments in the Libor scandal and “we continue to evaluate our options.”

  Many local universities also used interest-rate swaps as finance tools over the past decade, including Harvard University and Lesley University.

Large medical institutions have also used interest-rate swaps. Partners HealthCare, the parent of Massachusetts General Hospital and Brigham and Women’s Hospital, used more than $500 million in swaps to offset interest rate risks in the past decade. A spokesman said it was too soon to tell if the scandal had any impact.

Andrew Caffrey, Todd Wallack, and Eric Moskowitz of the Globe staff contributed this report. Steven Syre can be reached at syre@globe.com.

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