The Libor Scandal Could Have Been Avoided: Opinion

NEW YORK ( TheStreet) -- The London Interbank Offered Rate is determined by the 16 banks participating in the London money market, including three of the U.S.-based "too big to fail" money center banks: Bank of America ( BAC), Citigroup ( C) and JPMorgan Chase ( JPM).

Libor is set at 11:00 a.m. London time and is fixed for a 24-hour period. A major portion of global financing is pegged to Libor, including an estimated $500 trillion or more of the exotic credit derivatives that played a critical role in the 2008 credit crisis.

During the "Great Credit Crunch" an easing of the Libor rate was the first signal that the crisis was subsiding, because Libor is a measure of lending confidence. Obviously if the Libor rate is rigged lower, it can only be done with collusion among the rate setters.

U.S. Treasury Secretary Timothy Geithner was the president of the Federal Reserve Bank of New York when the credit crisis hit. It has been documented that in 2007 the New York Fed was alerted to suspiciously low Libor rate submissions. In 2008, Geithner discussed the issue with the governor of the Bank of England.

It seems Geithner did not act prudently in an effort to stop this potential rate fraud right then and there. In my judgment, he chose to look the other way. After all, the artificially low Libor rate showed that the Federal Reserve's credit facilities were working to free up the credit markets.

It also appears that the rate-setting banks did not want to post accurate rates. If one bank gave an individual rate higher than the other banks in the group it would have implied that that bank had to pay a higher rate to attract funding and would have raised questions about its health.

This is not the first time that I opined that bank regulators do not properly apply regulatory guidelines. In my articles about regional and community banks I have discussed the regulatory guidelines that were put in place in December 2006 for commercial real estate loans.

In my July 16 article "Assessing 29 Community Banks That Report Quarterly Results," I described the regulatory guidelines with regard to risk exposures in real estate lending.

Instead of taking action when banks reported too much exposure to real estate loans, the Treasury, the Federal Reserve and the Federal Deposit Insurance Corp. ignored these guidelines because the real estate market was hot and the banking system was generating record revenue.

Then came the "Great Credit Crunch." Since the end of 2007, the FDIC has had to close 452 banks and has put another 772 FDIC-insurance financial institutions on its problem list.

The Libor rate is the blood flowing through the toxic derivative contracts that Warren Buffett called financial weapons of mass destruction. What can't be marked to market should be banned.

I was a Treasury trader at one of 12 primary dealers between 1972 and 1977, back in the days before 24-hour trading and markets appearing on computer screens.

Each primary dealer had a representative meet once or twice a month with officials at the New York Fed, which regulated the primary dealers. Sometimes a trader from the New York Fed's open market desk participated.

The purpose of these meetings was to exchange thoughts on the economy and markets. I represented my firm many times during this period. At times we even met with Peter Sternlight, the president of the New York Fed.

The open market desk would occasionally call me at my trading desk to get a "feel" for market conditions. When the bond market was stressed, someone at the desk would give me orders to buy or sell securities into this over-the-counter market.

In other words, the Federal Reserve's open market trading desk would manipulate the market to stabilize Treasury yields. We called this action by the Fed buying or selling "under the table." This activity was not a part of implementing monetary policy.

All of this is to say that the U.S. and U.K. central banks have close communications with money center banks and typically know what is going on in bond and interbank lending markets.

With regard to the Libor situation, it appears to me that the Fed looked the other way because a lower Libor rate would reflect a healthier money market, which was the objective of monetary policy.

In decades of personal borrowing and lending, I do not recall having a loan tied to Libor. All my mortgages over the years have been traditional. I had a Tax Advantage Credit Line against a resort/condo unit I owned in St. Pete Beach, Florida, which I sold in January 2012. This loan was tied to the prime rate, so with the federal funds rate at zero to 0.25%, the rate was just 3.25%.

I have a business line of credit. Since 2007, it was at the prime rate plus 250 basis points, for a rate of 5.75%. My bank was one of the "too big to fail" banks. It obviously is not interested in lending to small businesses as it raised the spread to 500 basis points in May, which bumped the rate up to 8.25%.

Perhaps the only impact for me was my money market accounts and bank CDs. If they are tied to Libor and this rate was artificially low, then I was shortchanged interest income since at least 2007. Am I going to collect the difference? I doubt it.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading Treasury securities in the primary dealer community. In 1981 he formed the government bond department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. Capital Markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy. You can reach Richard at RSuttmeier@gmail.com