Philly suing world’s largest banks over Libor scandal…in which we explain the Libor scandal

boaThe city of Philadelphia is suing several of the world’s largest banks—including Bank of America Corp, Barclays Bank Plc, Citigroup Inc, Credit Suisse Group AG, Deutsche Bank AG, J.P. Morgan Chase & Co, Royal Bank of Canada, Royal Bank of Scotland and UBS AG—over the London Inter-Bank Offered Rate interest-rate rigging scandal which occurred before the Great Recession, according to a press release the city put out yesterday.

We are the most recent of several municipalities in the U.S. to file a suit. Other local governments getting in on the suing include Baltimore, San Diego, Sacramento and Houston. According to the press release:

The City of Philadelphia filed a lawsuit in the U.S. District Court for the Eastern District of Pennsylvania against a number of Wall Street banks responsible for setting the London Inter-Bank Offered Rate (“Libor”), alleging that the banks’ efforts to suppress Libor caused significant financial harm to the City of Philadelphia, and many others, on Friday, July 26.  The suit was filed on behalf of the City by Quinn Emanuel Urquhart & Sullivan LLP, Obermayer Rebmann Maxwell & Hippel LLP and Boni & Zack LLC.

The complaint alleges that by mid-2007 the banks were secretly conspiring to suppress Libor – an index that was used to set the parties’ obligations under certain financial instruments.  By conspiring to lower the reported Libor rate, the banks artificially reduced the amounts they would have to pay to the City of Philadelphia and increased how much the City of Philadelphia had to pay, causing the City to lose the promised financial benefits of the instruments.

“Cities and others paid for those benefits in reliance on the trustworthiness of the Libor rate, and on other rates based on Libor.  The systematic suppression of Libor, as our attorneys have uncovered, caused financial harm to the City of Philadelphia,” said Rob Dubow, the City’s Director of Finance.

What’s that? You’re don’t understand what the Libor scandal is? It’s OK. We didn’t really, either. Business Insider actually called it “incredibly complex” when it first hit headlines in 2012. So let’s figure it out.

It starts like this: Money and the world is supposed to work a certain way. For instance, you benefit from public services. Things like police, fire departments, hospitals, schools and libraries are there for you. Those things are parts of cities and governments and have their money invested in things like derivatives, currencies, mutual funds and pensions. Those things are directly tied to Libor.

Libor is an interest rate; the most widely-used rate in the world and the benchmark for many other rates often used in commercial loans, mortgages and other loans. Estimates for how much money is tied to Libor, according to USA Today, have varied from $350 trillion to $800 trillion. To put that in perspective, the entire world GDP is about $70 trillion–$15 trillion of which makes up the U.S. GDP.

What happens in the world of money is, London banks tell Thompson Reuters the interest rate they expect to pay on a loan from another bank. Thompson Reuters averages the rates, money is borrowed, and everyone’s happy.

Except not. The controversy stems from the fact that some banks either artificially inflated or deflated their interest rates to benefit themselves.

During the 2007-2009 period you and I joyously suffered through, banks often communicated with each other in order to submit lower borrowing rates to be calculated. They did this to appear healthy—even though they were sort of the opposite of that. Banks lent at lower interest rates, collected less profit in return and their clients—which often included cities and governments and financial institutions—in turn, received less cash which went to the police, fire departments, etc.

Meanwhile, everything went to shit. Banks were bailed out. The U.S. government created its stimulus program, but many of the projects the federal government invested in were not “shovel-ready,” and now the money’s basically run dry. Remember?

Terribly, the New York Federal Reserve Bank knew about the rigging and suggested a change in the process—but the British Bankers Association, which oversees Libor, was slow to respond.

Those cities which are suing are doing so both because of the inflated and deflated rates. Philadelphia is also claiming in its lawsuit that it had to pay “sometimes devastating” penalties to terminate its investment agreements—which includes nearly $110 million between 2009 and 2011.

The interest rate swaps “have cost state and local governmental entities hundreds of millions or even billions of dollars, depleting treasuries, ruining budgets, and hindering the delivery of public services,” according to the lawsuit.

Follow Randy on Twitter: @RandyLoBasso

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