The Biggest Banking Scam Ever

LONDON -- British bank Barclays (LSE: BARC.L  ) is at the dead center of a storm involving the manipulation of interbank lending rates.

Big fines for Barclays
The big boys at Barclays have been very naughty. The bank has been fined 59.5 million pounds by City watchdog the Financial Services Authority for manipulating a benchmark interest rate known as LIBOR -- the London Interbank Offered Rate. By agreeing to settle at an early stage, Barclays got a 30% discount on what would have otherwise been an 85 million pound penalty.

In misconduct described by the FSA as "serious, widespread and extended over a number of years," Barclays' bad behavior allegedly involved a considerable number of employees. Hence, the FSA had no choice but to hand Barclays the largest fine ever levied in the regulator's history.

Worse still, American regulatory authorities slapped even larger fines on the bank. The U.S. Commodity Futures Trading Commission imposed a penalty of $200 million on Barclays in settlement of attempted manipulation and false-reporting charges. Also, in an agreement with the U.S. Department of Justice, Barclays admitted misconduct and agreed to pay a further fine of $160 million.

In all, these three hefty fines total around 290 million pounds, or roughly 2.4 pence for each of Barclays' 12.2 billion shares in issue.

The great LIBOR fiddle
What Barclays' staff did was remarkably simple.

To help the bank's trading positions between 2005 and 2009, and most notably during the global financial crisis of 2007 to 2009, the bank made false submissions to the LIBOR-setting committee, which sets rates daily in London.

At the request of its own traders of interest rate derivatives, Barclays made false submissions relating to LIBOR and Euribor (the eurozone benchmark rate). By manipulating LIBOR, Barclays personnel aimed to help their trading colleagues profit.

Rigging the world's leading benchmark for interest rates is pretty serious stuff. Indeed, in the words of the FSA, "Barclays' behavior threatened the integrity of the rates, with the risk of serious harm to other market participants."

As a result, Bob Diamond, Barclays' chief executive, has agreed to forego his yearly bonus in 2012 (it was 2.7 pounds million for 2011), as have senior executives Chris Lucas, Jerry del Missier, and Rich Ricci.

Many LIBOR lawsuits to come
In other market-rigging scandals, it is rare to see only one party involved. Indeed, when investment bankers see their rivals making money hand over fist, they are all too keen to board this bandwagon -- even if the actions involved are banned.

Thus, these fines handed down to Barclays are surely only the tip of the iceberg. As the old saying goes, "There's never only one cockroach under the fridge," and the same warning applies to bad bankers.

Therefore, I expect other banks -- in the U.K., U.S., and elsewhere -- to be engulfed by this scandal. If any of the global banks, such as HSBC (LSE: HSBA.L  ) , JP Morgan Chase, or Citigroup (NYSE: C  ) , admit similar charges, then their fines could dwarf those levied on Barclays.

Furthermore, although Barclays has settled with U.K. and U.S. regulators, there will be many more civil -- and even criminal -- lawsuits in the pipeline. This threat should trouble shareholders in HSBC, Lloyds Banking Group (LSE: LLOY.L  ) , and Royal Bank of Scotland (LSE: RBS.L  ) , as all three British banks have been named in LIBOR lawsuits.

Sickening news for shareholders
What is truly breathtaking is the sheer scale of this fraud.

According to one estimate, around $350 trillion of lending and derivatives is priced off LIBOR. Thus, if misconduct by banks caused LIBOR to increase by a mere 0.001%, this amounts to $35 billion a year in extra interest.

One official claims that 20 other banks helped to rig interest rates and that Barclays is poised to "blow the whistle" on wrongdoing at its co-conspirators. It's also likely that criminal charges could be brought against the ringleaders of this worldwide fraud.

Due to the vast scale of this illegal activity, LIBOR lawsuits, fines, and damages could be an existential threat to Barclays and other banks. Shareholders should forget about the damage to banks' reputations, which are already in the gutter. Instead, they should worry about the very future of the banks involved.

Think about this: class-action lawsuits in the U.S. and mass lawsuits in the U.K. from mortgage borrowers, loan customers, and millions of businesses, all of which paid more interest because of this fiddling of LIBOR. Scary stuff, agreed?

Bank shares slammed
With this scandal now out in the open, spooked bank shareholders raced for the exits.

Here's how the shares of the Big Four banks have performed since news of these settlements broke on Thursday (from largest fall to smallest fall):

Bank

Closing Price, June 27 (pence)

Closing Price, June 28 (pence)

Change (%)

Barclays

196.05

165.6

(15.5%)

RBS

233.1

206.4

(11.5%)

Lloyds

31.16

29.94

(3.9%)

HSBC

573

558.2

(2.6%)

Source: Yahoo! Finance UK, June 29, 2012.

As you can see, Barclays and RBS shares got hammered on Thursday, losing nearly 16% and 12%, respectively. Lloyds got away with a 4% drop, while HSBC slid less than 3%.

Shunning bank shares
Even five years after the credit crunch arrived, the banking world is still not back to "normal," which is why I avoid U.K. banks like the proverbial plague. I don't own any bank shares today and have bought none since 2007.

Britain's biggest investor, Neil Woodford -- who manages 20 billion pounds of our money for Invesco Perpetual -- also shuns bank shares. To find out which great British businesses Woodford is buying, read "8 Shares Held By Britain’s Super Investor." For more about these eight money-making machines -- and Woodford's magnificent mind and methods -- download your free copy of this report today.

Without doubt, the rigging of LIBOR is shaping up to be the most serious financial scandal of the 21st century. Indeed, if criminal charges succeed against any bank involved, then they could well spell the end of that institution, so watch this space closely.

More from Cliff D'Arcy:

Cliff does not own any of the shares mentioned in this article. The Motley Fool owns shares of JP Morgan Chase and Citigroup. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On July 02, 2012, at 12:29 PM, ilovesumm wrote:

    There have been no criminal charges or sactions from the SEC banning them from continuing to work in the industry?

  • Report this Comment On July 02, 2012, at 2:38 PM, JacksonInVA wrote:

    I stay away from banks as an investor and a customer. It semms that banks cannot make an honest buck.

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