Posted Jul 11, 2012 02:20 pm CDT
The city of Baltimore is at the forefront of a federal court battle alleging banks artificially depressed a benchmark rate for borrowing, leading to large losses for cities that entered into interest rate swaps.
The banks are accused of improperly lowering the London interbank offered rate, known as Libor, the New York Times Dealbook blog reports. Dozens of suits against more than a dozen banks have been consolidated into a few cases. The plaintiffs are municipalities, pension funds and hedge funds. Now other cities and states are also considering legal action, the story says.
The issue has been in the news after Barclays admitted last month that it tried to manipulate Libor during the financial downturn and paid $450 million to settle charges. Barclays said it understated the rate to appear in better shape. Libor is determined based on bank estimates of the rate at which they could borrow funds from other banks. When the Fed cuts interest rates and Libor rates skyrocket, the suggestion is that banks are nervous about getting back money they lend, even to each other, reports U.S. News & World Report.
An artificially low rate may benefit consumers with mortgages and those with student loans whose rates are tied to Libor, the stories say. But cities with interest rate swaps and traders who entered into futures contracts to protect against interest rate spikes will suffer, DealBook says.
Cities that pay bondholders based on a floating interest rate use a swap to pay a fixed rate and protect themselves from interest rate increases, Washington’s Blog says in a report referring to several stories. The cities in a swap often pay a fixed rate to a bank and receive a variable rate in return.
The plan can backfire DealBook explains. “If Libor is artificially lowered, the municipality is stuck paying the same fixed rate, but it receives a smaller variable payment from its bank.” Peter Shapiro, who advises Baltimore and other cities on the use of such swaps, says state and local governments lost money because of the manipulation. “The number is likely to be very, very big,” he said.
Banks, on the other hand, argue that many factors influenced Libor. They are seeking dismissal of the suits.