What Is The Libor Worst-Case Scenario?

Worst-case financial situation

Worst-case financial situation
The financial press has been in overdrive trying to keep up with the news related to allegations of Libor manipulation by the major global banks.  Often the press is lured by a scandal, a flashy headline, or a damning email that all make for good copy. But is the investigation surrounding Libor really as alarming as the bold-face headlines would have us believe?

In a word: Yes.

The simple truth is that Libor-related litigation has the potential to bankrupt global institutions, unseat senior management and change the primary index used by the world of finance. The sub-prime mess in the United States resulted in a dramatic shift in which many financial institutions were left insolvent. Similarly, the Libor fallout could result in major global banks facing financial instability caused, not by credit losses, but by litigation and settlement costs.

How Big Are We Talking Here?

CheatingLibor: The Trillion-Dollar Question

Read my earlier post about Libor for more analysis of the scandal and its ramifications.

If this sounds like hyperbole, consider the possible results of the lawsuits that are already filed or that are being considered by potential plaintiffs. If plaintiffs are able to prove in court that banks on the Libor panels submitted false quotes intentionally, they may seek to recover the losses sustained by their investors. If traditional remedies are employed, even a basis point or two shift in Libor could have cost investors many billions of dollars. If that manipulation took place over a period of years the losses could mount into the tens of billions. Add in the regulatory fines and litigation costs associated with the matter and the costs could quickly deteriorate the already strained capital reserves of even the strongest institutions.

Unlike the subprime lawsuits related to home mortgages, the parties that would have been injured by a corrupted Libor are the largest investors in the world with exceedingly deep pockets and battalions of lawyers at their disposals. Should a single asset manager win against one of the banks accused of manipulation, nearly every investor in the world may consider seeking recompense.  Should the matter wind up a class action, I believe it could wind up one of the largest such actions ever initiated.

The Less-Than-Worst-Case Scenario

Despite the thousands of pages of newsprint that have been devoted to the matter to date, only one institution has admitted any misconduct at all regarding their bank’s Libor submissions. It is entirely possible that the matter concludes with the penalties to date and any directly related litigation and no additional suits. That would certainly be the cheerier outcome for the banking world.

The Worst-Case Scenario

The reality is that investors in the form of banks and assets managers have already started litigation based on claims related to Libor manipulation. Yes, the press paints an ugly picture sometimes, but the worst-case scenario is that some of our largest global banks could be rocked by crushing legal costs and penalties at a time when regulators are desperately seeking to increase capital reserves.

Should the worst-case scenario materialize, bank supervisors and politicians around the world may need to intervene to prevent the tidal wave of litigation that could sink our banks.

It’s not time to be alarmed, but be alert. Libor is a story that could be making headlines for some time.

About Richard Magrann-Wells

Richard is a Executive Vice President with Willis Towers Watson’s Financial Institutions Group based in Los Angel…
Categories: Financial Services

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