Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)  may find winning its case against over a dozen large banks for alleged manipulation of LIBOR interest rates may not be easy.

Fannie Mae

In a recent article posted in the financial blog ‘Sober Look’, the author highlights the idea proposed by The Office of Inspector General of the Federal Housing Agency (FHFA-OIG) on using the Fed’s measure of deposit rates as the bench mark, instead of LIBOR.

According to an internal staff memorandum report from FHFA-OIG, Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) (collectively,called the Enterprises), rely upon LIBOR for the determination of interest rates payments on their sizeable investments in floating-rate financial instruments, such as mortgage-backed securities and interest rate swaps.

The FHFA-OIG report estimates that during conservatorship, the Enterprises may have suffered about $3 billion in cumulative losses from the LIBOR manipulation.

Fed ED vs LIBOR

The Fed publishes Eurodollar Deposit rates (Fed ED) for 1-month obligations. FHFA-OIG report notes like LIBOR, this data series are designed to measure short-term bank borrowing costs via pooling of financial institutions. The internal memorandum report, however, feels the Federal Reserve measure pools a broader range of institutions and is rarely referenced in floating rate obligations.

The report examined the daily rates for 1-month Fed ED and 1-month LIBOR and found the two rates remained very close for the period reviewed, from beginning of 2000 until mid-2007. However, as the financial crisis began to metastasize, these two rates began to diverge substantially.

Fannie Mae and Freddie Mac Should Have Received More Interest

According to the recent financial blog article in ‘Sober Look’, by comparing the two indices, one would come to the conclusion that the portfolio held by Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC)  should have received more interest income than it did. This is evidenced from the following graph as well:

Freddie Mac Portfolio

Uphill Battle

Though the above comparison might sound like solace for the Enterprises, the financial blog notes that unfortunately it is going to be an uphill battle. The author cites a couple of reasons to justify his views.

For instance, since banks reporting to the BBA are larger on average than those in the Fed’s sample list, the banks can argue that their borrowing costs and hence LIBOR, during the crisis would have been lower because of their size, even without manipulation.

Secondly, the Fed gets its deposit rates from “Bloomberg and CTRB ICAP Fixed Income and Money Market Products”. However, the author cites British regulators describing the arrangement between ICAP and UBS involved UBS making quarterly payments to ICAP to allegedly reward brokers for helping rig LIBOR.

Thus, the author of the financial blog at ‘Sober Look’ concludes that with enough doubt introduced, the banks will claim that the damages due to the actual LIBOR manipulation are significantly lower than what could be determined from the difference between LIBOR and Fed ED.