Libor rigging and ARM loans: Another realm of bank collusion?

Since I have not put up a post in over two months, I am doing this quick post to keep the blog fresh. Meanwhile, I have several posts in the works for July. The following excerpt is from a feature story I did for Dollars & Sense magazine. The article provides a summary of the Libor (London Interbank Offered Rate) rigging scandal and its outcome, but more importantly dives into what I argue is a missing dimension in the scandal — inflated Libor rates applied to adjustable rate mortgage loans (ARMs).

The article stems from research I was hired to do for a class action certification effort by a Vermont attorney alleging wrongdoing by Libor panel banks in the form of inflated rates applied to ARM resets (repricing per the adjustable rate terms specified in the loan agreement). You can read the full story here (“Libor rigging redux: Was there a third dimension to the Libor scandal?”).

Below is an excerpt that should help you understand what is meant by the idea of a missing dimension in the Libor scandal. It is based on my original research using Libor rates and other mortgage rates used in pricing ARM loans:

The results of my statistical tests found a significant Libor upward bias—rates higher than they should have been—just ahead of the monthly resetting of hundreds of billions of dollars’ worth of mortgage loans in the period of January 2004 through August 2007. For example, in one of my tests, the second-to-last business day of the calendar month (the day used to reprice most conventional ARM loans) had a pronounced increase of 54 basis point during the period I was examining—about half a percentage point of total extra rate charges applied to millions of resetting loans during the same period. (A basis point, as a measure of an interest rate, is one one-hundredth of one percent.)

The 54 basis points alluded to above refer to a statistically significant net positive change in the spread of the 6-month US Libor over the US Treasury Constant Maturity rate (CMT) on a day that was used to reprice millions of ARM loans. On any of the other business days of the month, there were no statistically positive net changes of the spread (the net spread change was statistically zero for the entire period), meaning the net change expected on any same day of each month should be zero, not positive. Therefore, these 54 basis points represent an unexplained, or anomalous, net positive change in the value of the spread (and extra interest income for banks on their ARM loan portfolios). Again, on any given calendar day of the month, the net change for the same day (like second to last business day of each month in the study period) statistically should be zero.

The only day where a net positive change was statistially detected (p value < .01) happens to coincide with the day of the month during the study period that Libor was used to reprice trillions of dollars in conventional ARM loans. While there may be another explanation for this movement (such as US dollar demand affecting CMT rates on this particular day of the month due to multinational firms’ buying dollars and then Treasuries at quarterly intervals), it is unlikely in my opinion to be the factor. And Libor rates, on their own terms (not only relative to CMT) show statistically significant increases (increased faster) during the last five business days of the month compared with the first five business days of each subsequent month. This despite an upward trend in the absolute level of Libor during the study period.

Stay tuned for two more posts before month end.

JS