Legal Theories in LIBOR and FX Lawsuits

While this article in CapLaw discusses the history of the allegations, investigations and lawsuits in the FX and LIBOR scandals, we thought it most interesting to focus on the legal theories and their current status.

In LIBOR, the US consolidated case held that there was no antitrust damage as the LIBOR rate setting process was not competitive in nature and thus there could not be anti-competitive behavior.  However, "second-generation" lawsuits filed by plaintiffs claiming direct trading losses from derivatives with banks that provided benchmark LIBOR rates, are moving through the legal system.  Two large plaintiffs are the FDIC, on behalf of 38 failed banks, claiming fraud and collusion were used by the LIBOR setting banks to suppress rates, and Freddie Mac and Fannie Mae, claiming that LIBOR manipulations caused them to suffer losses on mortgages and financial derivatives.

LIBOR cases in the UK have been limited, with only two cases filed, one of which was settled and the other remains with the courts.

In the FX benchmarks, the US has consolidated numerous class action suits into one.  Differences between the rate setting process in FX vs. LIBOR make it unclear whether antitrust charges will hold up in the FX case.  Fraud and collusion charges remain in FX as well, but the later start of FX allegations, the complexity of the cases and the continuing regulatory and internal bank investigations, means that further clarity will not be forthcoming until at least late 2014.

Fannie, Freddie say overhaul would boost mortgage rates.

WSJ reports that Fannie and Freddie have written a memo stating that an overhaul of the mortgage market that excludes them would (surprise) increase the cost of a mortgage. With the midterm elections this year and lack of consensus even among Republicans, the smart money would bet that no reform bill gets passed this year. The WSJ link contains links to download the memos. The Senate bill being considered by the Senate Banking Committee would replace Freddie and Fannie with a system whereby private companies can package mortgages into federally insured mortgaged backed bonds. I have not yet studied the bill so cannot comment in a substantive manner but conceptually I do not see how the proposal can be better than what we have today. I am not saying that Fannie and Freddie are faultless for their roles in the credit crisis but a solution of a distributed system but with the federal government still on the hook seems like it could create as many problems as it solves. 

More Answers than Questions - the Hank Paulson Story

If ever there was a man who had "more answers than questions" - as the cliche on a cliche goes - it's Hank Paulson.  But let's give him his due.  He's a hard-working guy.  He rose to high prominence and stayed there.  He's as honest as the day is long (not meant to be a joke that we're writing in winter).  His signature is on the currency we all use.  You can't beat the career credentials.

In today's news, though, he's making a comeback to tell us all that there are still big financial problems.  We know that!  While it's not offensive to state the obvious, we need more content than that.  We need a bigger message with REASONS and proposed ACTIONS.

Well, Paulson does have talking points.  He focuses on Fannie and Freddie and the government's dominance and ownership of residential mortgage lending since the Crisis.  Paulson:

    "It perplexes me that nothing has been done [by Washington politicians to unwind his own takeover of Fannie and Freddie as Treasury Secretary in 2008]."

He's perplexed that Washington wants to retain government control?!  Then Paulson says:

    "Every financial crisis has its roots in flawed government policies that lead to excesses in the markets that build up and build up, and then you get a bubble and it bursts."

In his very next breath, Paulson chides a group that is TRYING to reform Fannie and Freddie with an accusation of "OVERSIMPLIFICATION."  And his explanation above of the bubble burst was ..... WHAT?  Brilliantly deep analysis?!  A problem with these Paulson statements is that he's not saying anything.  There's no content.  It's surface-level thinking and reacting.

We read On the Brink, Paulson's book about the Crisis published in 2010.  The book is valuable as historical record.  (We recommend it.)  What is most striking is the absence of any Paulson thoughts.  The man just does not think deeply about the ways of the financial world.  A recurring theme of Paulson's in the book is (paraphrase) "I didn't have time to explain to House and Senate members why it was necessary to spend $700 billion and bail out the banks.  They just wouldn't have understood.  The financial world is too complicated to explain quickly to non-experts."

OUR QUESTION:  Well, why not tell us in your book, Mr. Paulson?  (In his book, he doesn't like strangers calling him "Hank.")  Every book begins with many blank pages.  Fill them with that long, complicated explanation that Congress couldn't understand.  But there's nothing there.  There's no discussion of whether banks are over-leveraged - for example, why is 20:1 leverage okay?  If it's not okay, what should it be?  Why?  (Leverage is just the first and easiest question!)

Reuters reports FBI suspects front running of Fannie, Freddie in swapsmarket

Yet another investigation into potential wrongdoing in the derivatives market.

http://mobile.reuters.com/article/idUSBREA0D04N20140114?irpc=932