Rafferty Capital Markets’ Richard X. Bove weighs in on the FDIC’s LIBOR-related lawsuit, laying out the questions and concerns he has about the issue.

Federal Deposit Insurance Corporation FDIC

Three Big U.S. Banks Accused of Manipulating LIBOR

The Federal Deposit Insurance Corporation (FDIC) is suing 17 banks, three of whom are U.S. based, for manipulating the London Interbank operating rate (LIBOR). There is no press release on the FDIC’s web site explaining what it is doing but apparently, the FDIC is claiming that the manipulation of LIBOR caused 10 banks to fail in the United States and the FDIC wants compensation for the losses it assumed.

To this outsider there are two issues that are unclear, if I understand this lawsuit:

  • If low interest rates cause banks to fail why isn’t the FDIC suing the Federal Reserve for artificially lowering short and long rates?
  • If these banks manipulated LIBOR while they were being audited virtually daily by the FDIC (the FDIC maintains offices in all three banks being sued) why isn’t the FDIC guilty of gross malfeasance and the real source of the 10 bank failures?

There is not enough data at this point to determine what the FDIC is doing here. However, it appears that the agency is simply following the “company line” and seeking some way to sue the banks that support its defense fund.

FDIC: Low Interest Rates Cause Bank Failures

If the press reports are correct, the FDIC is claiming that by artificially lowering interest rates, the big banks that set LIBOR caused 10 small banks to fail. The FDIC was forced to rescue these institutions and the banks that allegedly manipulated LIBOR should pay the FDIC for its trouble.

The core of the FDIC argument would appear to be that lowering interest rates causes banks to fail, presumably because banks are asset sensitive and:

  • The yield on asset falls faster than
  • The cost of liabilities.

This theory is unique since most of the academic work completed on banking argues the opposite. In fact for decades the Federal Reserve has been criticized for lowering interest rates to help bank profits. It will be fascinating to review the FDIC’s arguments, if they ever make it to court, indicating why the body of work completed on interest rates and banking is dead wrong and lower interest rates are harmful to bank profits.

It will also be interesting to see why the FDIC believes that manipulating LIBOR lower caused banks to fail and the Federal Reserve’s actions to lower these same rates through cutting the Federal Funds rate had no impact on the process.

The probability, however, is that this case will never make it to court. This is because the banks will be literally petrified to defend themselves against an agency that can meaningfully harm their ability to do business. This law suit is simply another example of extortion by the government to benefit for the agency running the extortion.
The loser here is the American people who own the banks being sued. Plus, if any precedent is being set that would reduce the ability of banks to lower interest rates, the losses to the economy could be even greater. But of course why would the FDIC, the press, and even the American people care if some money can be extorted out of big banks.

Accountability

For years Sheila Bair, the past director of the FDIC and Martin Gruenberg the current head of the agency have taken a position that the banks that they audited performed illegal and improper actions. Both executives were in leadership positions at the FDIC from the middle of 2005 to, in Mr. Gruenberg’s case, the present. The Financial Crisis Inquiry Commission (FCIC) stated clearly:

“We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets.”

The FCIC goes so far as to state that the financial crisis was avoidable if the regulators had done their jobs. Who were the regulators who the FCIC must be talking about? Clearly among them were the heads of the FDIC. Yet, Martin Gruenberg was promoted from Vice Chairman to Chairman of the FDIC and Sheila Bair has a cushy assignment at one of the big banks that she said so often were a danger to the financial system.

There has been no accountability in the government for actions not taken. Now the Martin Gruenberg is suing the big banks for taking questionable actions during the period when he was entrusted to discover and stop these activities. If his lawsuit is correct, then he did not do his job and he will never be held accountable for it. At some point I assume he will also take a cushy job, as Ms. Bair did, at some big bank, one that he is suing at present.

When do the American people get a break? When is the press going to wake up and deal with this lack of accountability? I am a pessimist in this area and I assume never.