Federal Reserve Chairman Ben Bernanke told Congress on Tuesday that a key global benchmark interest rate remains "structurally flawed" and acknowledged as indefensible the spate of banking scandals that have become near-weekly occurrences in recent months.
As Bernanke testified before the Senate Banking Committee, another committee was exposing how global bank HSBC Holdings allowed drug traffickers and money launderers access to the U.S. and global financial systems. The information, released by the Senate Permanent Subcommittee on Investigations, which earlier spotlighted much of the wrongdoing that led to the 2008 financial crisis, was the latest in a long string of recent reputational hits for key players in the financial sector.
These include massive trading losses by U.S. giant JPMorgan Chase, missing money associated with the collapse of investment bank MF Global and this month's bankruptcy of the Peregrine Financial Group, which included a suicide note admitting years of embezzlement by founder Russell Wasendorf Sr., who's now in jail after his suicide attempt failed.
As financial controversies pile up, the scandal surrounding the benchmark interest rate called the London Interbank Offered Rate - Libor - took front and center at the Banking Committee hearing, which ostensibly was about the U.S. economy.
Lawmakers pressed Bernanke on why the Fed didn't warn more loudly about the manipulation that was occurring to an interest rate that's used as a benchmark in financial markets across the globe.
"The Libor system is structurally flawed," Bernanke told the senators, suggesting it might be better to replace it with something else.
The Fed chief testified that he first learned of the interest-rate fixing around April 11, 2008. Days later there were news reports that the British bank Barclays and perhaps other banks were manipulating the information they contributed to the collectively set rate.
The original information was received by the Federal Reserve Bank of New York, from an employee of Barclays. The bank's tipster, Bernanke said, had told the Fed that Barclays' borrowing costs for overnight loans from other banks were higher than it was reporting.
Barclays did so to avoid financial markets perceiving it as weak after the collapse of U.S. investment bank Bear Stearns, of which the Bush administration orchestrated a fire sale to JPMorgan Chase in March 2008 to prevent a financial panic.
A transcript Barclays released of a phone call between a bank official and Fed analyst Fabiola Ravazzolo showed how the Fed was informed about what Bernanke acknowledged in Tuesday's hearing amounted to fraud. The trader told Ravazzolo that Barclays, if offering a false number, was trying to avoid "unwanted attention."
At the time, Timothy Geithner, who's now the treasury secretary, headed the New York Fed. He and Bernanke are now under fire for not articulating the need to revamp Libor more forcefully.
Libor is a benchmark interest rate set collectively by a panel of banks that operate in Britain, some of them American. They submit information about the cost of borrowing from other banks and it's calculated by information giant Thomson Reuters. Executives from JPMorgan Chase and Citibank recently have confirmed that they're cooperating with international investigations.
Libor is used as a reference for trillions of dollars in loans and securities transactions. It's employed in calculating everything from the rate to which some U.S. adjustable-rate mortgages reset to the complex financial products called derivatives.
U.S. and British regulators announced a record combined $450 million fine against Barclays PLC on June 27 for the Libor manipulation. Days later its CEO, Robert Diamond, resigned.
It's not entirely clear whether American consumers were directly harmed, especially since Barclays was reporting a lower rate than the actual one for part of the period in question, which Bernanke noted may have resulted in lower borrowing costs for consumers. Florida Republican Gov. Rick Scott sent a letter to the state's congressional delegation Tuesday, asking its members to focus on the issue "to determine the extent to which Libor manipulation may have driven up interest rates" for families.
Once news of the manipulation broke in 2008, the Fed made recommendations to the British Bankers' Association for revamping Libor. Most, Bernanke said, weren't adopted.
The Libor scandal has further eroded confidence in big banks, the integrity of the financial system and even Bernanke and the Fed, lawmakers said Tuesday.
"I'm not defending it. It is a major problem for our financial system, and the confidence in our financial system, and we need to address it," Bernanke said in response to tough questioning from Sen. Robert Menendez, D-N.J.
Adding to mounting distrust, London-based HSBC Holdings acknowledged before and during Tuesday's parallel hearing that its lax controls had allowed Mexican drug cartels to launder their illicit gains through the bank's U.S. arm.
It issued a statement of apology hours before the hearing, acknowledging that "in the past, we have sometimes failed to meet the standards that regulators and customers expect."
The bank added that it recognizes "that our controls could and should have been stronger and more effective in order to spot and deal with unacceptable behavior."
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