Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

Who suffers from playing games with LIBOR?

with 5 comments

Earlier post discussed the blooming scandal over LIBOR rates.

Short version – Barclays has admitted it underreported borrowing costs which in turn affected the LIBOR rate, which is the base for calculating the interest rate on many loans.

The populist-type comments I’ve seen so far suggest that consumers are being ripped off. 

I don’t think so. Consumers aren’t the ones who suffer.  Here’s why:

If the gargantuan banks are underreporting their borrowing costs that means LIBOR is lower than it should be, which means interest rates that consumers and businesses are paying on their loans are lower than they should be. In other words, consumers and businesses with debt tied to LIBOR are getting a break.

(By the way, the news coverage now suggests that it’s more than just Barclays that was underreporting their borrowing costs. That is why we should start paying attention, because if correct, this issue is going to expand widely and rapidly.)

If consumers aren’t the ones suffering, then so what?

Every loan has two sides. If consumers are underpaying compared to what the real LIBOR would have been if reported correctly, then their creditors are forgoing interest income. That means that smaller banks who hold loans tied to LIBOR along with pension funds, insurance companies, and anyone else who loaned money based on LIBOR has been shortchanged.

The lenders got shortchanged by Barclays.

Loss of trust may be the bigger casualty. Or rather increasing loss of trust.

The more serious issue is that this will play into the lack of trust many people have for large financial institutions, especially the huge banks. The populist play will be “they are just ripping us off”, even though consumers got a break on their interest payments.

There will be serious political backlash, which has already started in England.

Perhaps the worst thing would be if smaller-than-money-center banks, pension funds, and insurance companies come to the conclusion that “they are just ripping us off.” That would be very bad.

Did the regulators know all along?

The articles I mentioned in the earlier post contain some comments that Barclays told the regulators that other banks seemed to be misreporting their borrowing costs. At first glance, this looks like the “everybody is doing it” defense.  Let’s look a bit deeper.

An article editorial in the Wall Street Journal, Barclays Bank Bash, (behind paywall) explains Barclays told multiple regulators of their concern:

Several times in 2007 and 2008 Barclays employees reported that large banks, to make themselves appear healthier than they were, claimed to be able to borrow at rates lower than the market was offering them. These communications from Barclays were directed to the Bank of England, the British Bankers Association and the Financial Services Authority in the U.K., and to the U.S. Federal Reserve Bank of New York, then run by Timothy Geithner.

So the Bank of England, BBA, UK FSA, and NY FRB had multiple tips in 2007 and 2008.

By the way, this isn’t a new issue. The WSJ has been reporting on problems in LIBOR for a long time. I haven’t looked up the articles, but do recall having seen articles for a while. (Update:  The WSJ says they first reported on problems with Libor in 2008.)

Stay tuned. I’m sure we will hear more.

Update:  At lunch today I read two more articles in the Wall Street Journal. My knowledge of the Libor mess is growing at an exponential rate. I thing the scandal is growing at an even faster rate.  That worries me.

My comments above were based on my understanding that the manipulation was limited to roughly the time of the fall 2008 financial crisis. If that were the case, then the damage would be to investors holding paper with interest rates based on LIBOR.

It now looks like the rate fixing was going on before the financial crisis and continued after.  If that is the case, then there is a financial benefit to Barclays and the other banks who were playing games with the rate. Who would be damaged then? I’m not so sure of the answer to that.

More discussion to follow!

Written by Jim Ulvog

July 6, 2012, 9:15 am at 9:15 am

Posted in Accounting

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5 Responses

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  1. […] post – who suffers? Like this:LikeBe the first to like […]

  2. Jim….As I recall, WSJ said it first reported on banks manipulating LIBOR 4 years ago…..5 issues come to mind……
    1. You hit the nail on the head on loss of trust. This is perfect example why customers don’t trust business.
    2. If management lies about LIBOR why how does PwC conclude they can trust management for financial reporting?
    3. How does PwC conclude there aren’t any material internal control weaknesses?
    4. Lying about LIBOR is a crime. That’s a violation of the extant SAS 54 Illegal Acts by Clients. Whatever revenue/profit is from the lie is illegal. If material PwC can not give a clean opinion. (Note that SAS 54 is being replaced by a Clarified Audit Standard effective for periods ending on or after 12/15/12 and now requires auditors to verify that the client is operating legally.)
    5. PwC is required to plan and perform the audit to have a reasonable probability (50+%) of detecting a material misstatement. Want to bet that ‘verify LIBOR rate’ isn’t in the audit program?

    Gary Zeune CPA
    The Pros and The Cons

    Gary Zeune

    July 6, 2012, 11:48 am at 11:48 am

    • Thanks for the comment Gary.

      I’m still getting my head around this. One of the obstacles I have is figuring out why the data reported for LIBOR is something that would be tested during an audit.

      The bank sends estimates of their borrowing costs to the British Bankers Association. BBA tosses out the high 4 & low 4, then averages the middle 8 10. That rate would come back into the bank as an index on which many loans and contracts are based.

      I could easily see an audit step to make sure that the rates reported by British Bankers Association are input correctly to the Barclays’ accounting system so that loans are priced correctly. Accuracy of interest accruals rides on getting that data input right.

      I am having trouble seeing why it would otherwise be necessary to test the data that is reported out.

      It’s been a long time since I audited banks and even then the ones I worked on didn’t have a balance sheet 1/10th the size needed to be a mere rounding error in the $2.35 trillion balance sheet of Barclays. As a result, maybe my vision isn’t large enough to see the reason.

      Check out the Economist article that is out today – I’ll discuss it tomorrow. – You’ll have even bigger questions that the 5 you’ve already asked!

      Jim Ulvog

      July 6, 2012, 12:58 pm at 12:58 pm

      • Jim….Why is it necessary to test the truthfulness of LIBOR rate to opine on financial statements? Because you can’t give a clean opinion on financial results resulting from fraud. In other words, SAS 54 says, just because the money is in the client’s checking account does NOT mean it was legally earned. Two different things. Current example, GlaxoSmithKiine just agreed to plead guilty to criminal charges and pay $3 BILLION to settle for off-label marketing. Absolutely illegal. The sales were made. The money was in the checking account. But the company earned the revenue/profits illegally. Exactly the types of activities auditors are required to design and perform the audit to detect under SAS 54. Closer to home. If you audit a car dealer and find out the client is charging $500 for new OEM shock aborbers but installing aftermarket that should have been $300, the $200 is in the checking account was illegally earned. The $200 is a liability, not revenue, because the dealer cheated the customer.

        The problem is that the Clarified Standard, Laws & Regulations, to be AU-C Section 250 as of 12/15/12, is fatally flawed. It requires auditors to inspect correspondence, if any, whether the client is operating legally. The flaw is that auditors are to request the info from the client. Once auditors tell the client they want to look at legal licenses or permits, the clients will simply log onto the license authority (eg, State Corporation Commission), grab the logo, paste it into desktop publishing, and make up what ever legal documents the auditors need. Think of it this way. If getting documents from the client is OK, why do we send bank and AR confirmations? I’m telling my ‘students’ to get the info DIRECTLY from the gov’t entity. Do NOT let it go through the client. The info would not be sufficient competent info if the client has the ability to fabricate the right to be in business.

        A perfect example was the infamous ZZZZ Carpet Cleaning case. 86% of all the revenue was fake for 5 years but 3 CPA firms missed it for 5 years. How was it busted? A reporter simply called the Secretary of State. CEO Barry Minkow and CFO Mark Morze forgot to get a contractors license. Make sense? If your readers are interested we have 100+ fraud videos on our web site. The last 8 or 10 are ZZZZ Best.

        Gary Zeune

        July 6, 2012, 18:51 pm at 6:51 pm

  3. […] claims, as I mentioned in my earlier post, are that the banks suffered because of lost interest income on their loans. They had loans which […]


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