“We didn’t stop burning witches because we invented science; we invented science because we stopped burning witches.” — René Girard

For banks and their investors, the Libor scandal may seem like ancient history. Starting ten years ago, banks paid a series of escalating fines to settle accusations they had rigged benchmark interest rates. Barclays was first out the gates with a $450 million settlement – and its CEO’s head on a stick. UBS followed with a $1.52 billion settlement a few months later, then RBS, then Rabobank. In 2015, Deutsche Bank coughed up a record $2.5 billion. All told, banks paid fines amounting to around $9 billion worldwide. They paid their dues, some replaced senior executives, and collectively they moved on.

For some former employees, though, that wasn’t the end of the story.

After the financial crisis, authorities had been under pressure to make individual bankers accountable for the economic collapse they were perceived to have caused. Attributing the financial crisis to criminal intent was no easy task but, with Libor, prosecutors now had something to work with. Aided by the banks, and egged on by public sentiment, they went after individual traders. 

“I do want to see criminal prosecutions,” campaigned the leader of the UK’s opposition party, Ed Miliband. “I do want to see those who’ve done the wrong thing – those who’ve committed what I think are atrocious acts – brought to justice.”

In total, 38 traders were prosecuted – 24 of them in the UK and 14 in the US. With one of the defendants characterised as the “greedy ringmaster of an international fraud conspiracy” and a “crook of the first order”, these prosecutions satisfied public anger towards bankers. They also deflected attention from the actions of banks’ senior management.

But were the cases brought against these traders fair? This week, US courts threw out a case against one of them, Tom Hayes, saying there was no provable case, after another court overturned the convictions of two Deutsche Bank traders a few months earlier. Hayes has already served time in the UK – he was arrested at home in 2012 and spent five and a half years in prison after being convicted of conspiracy to defraud in 2015.

Hayes has long protested his innocence, claiming that he was simply playing by the rules of the game. Sadly, it is a story as old as time. Humans need scapegoats to defuse conflict and traders such as Tom Hayes represent the ideal scapegoat. ¹

For four years between 2006 and 2010, Tom Hayes worked as a trader in Tokyo, first at UBS and then at Citigroup. His job was to handle derivatives linked to Japanese interest rates and he was good at it. In his first full year of trading for UBS, he raked in $48 million in revenue for the bank and in 2008 – a year of losses across the industry – he made $89 million. When he was poached to Citigroup in 2009, he was awarded a $3 million signing-on bonus. 

Like other traders in interest rate derivatives markets, Hayes monitored Libor very closely. Libor was a rate published once a day, reflecting the price at which banks can borrow money from other banks. It had been devised in 1969 by a Greek banker called Minos Zombanakis, an employee of Manufacturer’s Hanover Bank. Zombanakis had been asked to arrange an $80 million loan for the Shah of Iran that would be syndicated among a number of banks. Normally, a big loan would carry a fixed rate but banks didn’t want to take the risk that their margin may be squeezed by rising funding costs, so Zombanakis proposed that they survey their funding costs on a regular basis and charge the Shah of Iran some fixed margin on top of that. The underlying rate became known as Libor – the London interbank offered rate. ²

In 1986, responsibility for administering the survey passed to the British Bankers Association (BBA). Each day, the BBA would go out and ask a panel of banks the rate at which they thought they could borrow from other banks across a series of maturities and currencies – including the yen version that Hayes used. At its height, Libor was published across ten different currencies and fifteen maturities. The base panel comprised 16 banks. The BBA would lop off the four highest rates and the four lowest rates and publish as its benchmark an average of the remaining eight rates. 

While Libor had been used first in syndicated lending markets and then in other loan markets, its use really took off in 1997 when the Chicago Mercantile Exchange (CME) adopted it as the reference rate for eurodollar futures contracts. The rate became “the most important number in the world”, as it grew to provide the benchmark underpinning hundreds of trillions of dollars of financial contracts globally. 

But it was still based on a survey. Unlike other benchmarks prevalent in financial markets, Libor didn’t reflect actual prices visible in a market. Rather, it reflected a hypothetical aggregate. Given the size of markets it went on to support, it wasn’t an ideal benchmark but finance is full of path dependencies, and once it had burrowed its way into those markets, the cost of switching became very high. Meanwhile, the BBA was heavily incentivised to sustain it: the organisation made money selling licences allowing others to incorporate the benchmark into their products. 

Perhaps reflecting its legacy as an informal average, or its home in London, where regulation was traditionally crafted around principles rather than rigid rules, Libor was loosely policed. As long as banks didn’t collude to move the rate in unison, they had a broad degree of discretion as to how they answered the Libor question. On any given day, there would have been a range of rates at which banks could borrow funds – they were free to set their rate within that range. The CME made that clear:

A contributor panelist who can borrow ‘in reasonable market size’ at any one of a wide range of offered rates commits no falsehood if she bases her response to the daily Libor survey upon the lowest of these (or the highest, or any other arbitrary selection from among them).

As they grew more sophisticated, traders used that discretion to attempt to influence the outcome of Libor. The impact any one trader could have was minimal, since, as an average, the published rate would net out the influence of contributors – but even a single basis point could make a difference given the size of banks’ derivative books. Citigroup, for example, reported in the first quarter of 2009 that if interest rates fell by 25 basis points a quarter over the next year, it would make $936 million in net interest revenue; if they fell by 100 basis points instantaneously, it stood to make $1,935 million. 

Unlike other areas of banking where strict “Chinese walls” are installed to prevent departments sharing information that could lead to conflicts of interest, few barriers existed between those employees who used Libor and those employees who submitted it. It wasn’t until July 2010 that Citigroup instituted such a division. UBS even had a system in place to aggregate positions across the group enabling it to assess its best submission for Libor (albeit one the bank denies was officially endorsed). The system was set up for Euros, Sterling and US Dollars. Unfortunately for Tom Hayes, it wasn’t set up for Yen – he had to rely on emails and instant messaging to communicate his preferred direction for Libor.

And what emails they were. A feature of the Libor scandal is that it was first to make public, alongside the regulatory judgement, an entire dump of internal communications from inside banks. It was these messages, in which traders call each other “big boy” and agree to do favours for a “bottle of Bollinger” that fed into public anger, coming so soon after the financial crisis. 

Hayes sent a lot of emails. “I dwarfed everybody else in terms of the number of my requests just because I’d be like, well if I’m going to do this, I’m going to do it properly,” he said. 

Emails tell a better story than statistical analysis and so attract more headlines. Yet statistical analysis shows that the practice of banks influencing Libor to suit their trading positions was widespread. In 2012, a pair of researchers updated a paper that proves this point. “The general picture of manipulation, painted by colorful emails discovered and testimony given, is one of the infrequent and idiosyncratic behavior of a few traders at a few banks,” they write. “Our results, by their very strength, suggest otherwise.”

For many years, the influence that traders had on Libor submissions went under the radar. But then, during the financial crisis, it blew into the open. The reason is that as markets seized up, banks were finding it harder to borrow funds – some more than others. Yet because their submissions were made public, an accurate assessment would have required them to advertise that fact to the market. Years earlier, a trader in New York had warned regulators of this risk at the time the CME was in the process of adopting Libor. “In a severe funding crisis…banks might respond to the BBA survey with a rate substantially below their true lending rate,” he cautioned. Now banks were in trouble, they were incentivised to do precisely that.

As market conditions deteriorated through 2007, senior executives and senior policymakers became aware of the signalling power of Libor and sought to influence it. Unlike traders, they didn’t use instant messaging to communicate their views, they used the telephone. In a recording unearthed by Andy Verity of the BBC, PJ, a Barclays cash trader in charge of submitting Libor rates, was in conversation with Miles Story, his head of group balance sheet management:

PJ: I’m proposing to go [5.]40 after going [5.]30 yesterday

MS: Mr Lucas [Group CFO] doesn’t want us to be outside the top end

PJ: Jesus Christ

MS: They chatted on the whole of the 31st floor, by the way [the executive floor of the bank]

By April 2008, Miles Storey was chairman of the BBA’s Libor committee. With market conditions still tight, he called the director of the BBA in charge of Libor and confessed that his bank had been inputting dollar rates ten basis points lower than where they should be. “No one’s clean-clean now,” the director replied. On a later call, they devised a plan to walk the rate back up. “So the idea is to see if we can gradually float the dollar rate slightly, gently up.”

These ten basis points were a lot more material than the single basis point or so that Tom Hayes shot for. Granted, the motivation was different. Hayes estimates that his attempts to get benchmarks moved contributed around $5 million a year to his trading revenues. Barclays’ actions in the depths of the financial crisis were motivated by a desire not to create panic. 

Yet prosecutors went after Tom Hayes and others like him rather than any of the participants involved in the “lowballing” of Libor. In fact, they even had to reinterpret the law to make convictions stick. In a judgement ahead of Hayes’ trial, Lord Justice Davis ruled that Libor submitters were required to provide a single assessment of the proper rate, irrespective of whether there was a range of “right answers” and should dismiss any commercial interest the bank may have in the outcome. His rationale: “How otherwise could the scheme ever work?” He went further: Given there was no indication in the BBA rules that the submitter was free to take the bank’s commercial interests into consideration, doing so was therefore deemed illegal. For anyone who'd worked on bank cash desks, this was a curious view to be applied retroactively. ³

No-one comes out of the scandal looking good. The Libor system was deeply flawed. But it was a system failure rather than an individual failure. Tom Hayes was no “ringleader” despite his prolific use of email. At the time of his conviction, his supposed co-conspirators – a group of inter-dealer brokers who intermediated between banks – were acquitted. Hayes himself was not charged in Japan, the country where the “crimes” took place. And now the US has thrown out its case against him. When the Second Circuit in the US reversed the convictions of two other traders earlier this year, it noted that while the traders’ efforts to impact contract outcomes by influencing LIBOR rates “may have violated any reasonable notion of fairness,” there was insufficient evidence of fraud.

But humans need a scapegoat and for a while that was Tom Hayes. He is currently hopeful that the UK’s Criminal Cases Review Commission will revisit his case and overturn it. When that happens, justice can at least be restored. 

Andy Verity’s podcast series The Lowball Tapes is worth listening to.