Diamond's crisis of Libor confidence

As US and UK investigators continue their rates fixing probe, and the potential costs of legal action escalates, Bob Diamond has warned of widespread Libor rates scepticism during the global financial crisis.

Giant global insurance and pension funds are watching the unfolding Libor scandal with intense interest, as they contemplate massive legal actions against the major banks involved.

They will have been particularly interested in comments that Barclays former boss, Bob Diamond, made to a UK parliamentary committee overnight which highlighted deep flaws in the Libor rate setting process.

Diamond noted that other UK banks – including those that required emergency government bailouts – were submitting lower rates than Barclays to the Libor process. This posed a risk to the Barclays, he said, because the UK government could decide that it also needed a bailout.

Diamond also told the committee that at the height of the 2008 financial crisis, there was widespread scepticism over whether Libor accurately reflected bank borrowing costs.

"We can't sit here and pretend there wasn't an issue with Libor," he said. "There was an issue out there and it should have been dealt with."

Last week Barclays last week agreed to pay a £290 million ($US453 million) fine – the largest ever in the City of London – to settle a UK and US probe that revealed the bank’s traders blatantly manipulated Libor to disguise the high cost of the bank’s own funding and to boost the profits of certain of it traders.

The cost of the fraud is massive. Libor, the London Interbank Offered Rate, is used as the reference point for an estimated $US360 trillion in financial contracts and loans. Even a one basis point (0.01 per cent) difference in Libor represents a cost of $36 billion.

But US and UK investigators are continuing their probe. The Royal Bank of Scotland and Lloyds Banking Group – both of which were partly nationalised in 2008 – have said they are assisting the investigation, and other global banks are also being questioned over whether they also took part in the Libor rate-rigging.

Already, major investors have signalled that they’re prepared to launch major legal actions against the banks to claw back some of the losses they’ve incurred as a result of the rate rigging.

The giant US financial services group Charles Schwab has launched a lawsuit against a group of banks, claiming that it bought about $660 billion of fixed-rate and floating-rate securities affected by the alleged Libor manipulation. Although Schwab does not nominate its exact damages, it claims in court documents that Libor-rigging banks reaped "hundreds of millions, if not billions, of dollars in ill-gotten gains" at its expense.

Other investors – including the city of Baltimore and the giant institutional investor, the Frankfurt-based Metzler Investment – have joined in proposed class actions against more than a dozen banks, arguing that the Libor manipulation deprived them of potentially billions of dollars in lost income. The banks involved in the case have filed motions to have it dismissed, arguing that there was no evidence that they acted jointly together to restrain competition.

But a number of the big global banks will be deeply worried. They know that the sums of money involved in the Libor scandal are immense. They also know that big institutional investors, pension funds and insurance companies, have deep pockets and will be prepared to launch lengthy legal actions to claw back some of the income they lost as a result of the Libor-rigging scandal.

Already, some believe that the banks caught up in the Libor rigging scandal will face costs that easily eclipse the billions of dollars that major banks have spent resolving US sub-prime related lawsuits.