In 2009, citing financial problems, the East Bay Municipal Utility District raised customer water rates by 15 percent and wastewater rates by 5 percent. In a press release at the time, East Bay MUD listed "more than $16 million in added expenditures for debt service for capital projects" as a reason for the rate hikes. Back then, agency officials assumed that the spike in financing costs was due to the bad economy. It turns out, however, that East Bay MUD, and by extension its 1.3 million customers, may have been illegally fleeced by the banks.
A lawsuit filed by East Bay MUD last month in federal court alleges that a handful of global banks engaged in a multi-year conspiracy to rig key interest rates in their favor, costing the utility millions of dollars. East Bay MUD's lawsuit is one of a fast growing number of civil complaints alleging that, between 2007 and 2012, a group of sixteen mega-banks illegally rigged the London Inter-Bank Offered Rate, or LIBOR. More than twenty LIBOR lawsuits have been filed against the banks, according to Daniel L. Brockett, a lawyer who tracks securities fraud litigation. The most recent round of lawsuits has been filed by California cities including Riverside, San Diego, and Richmond, plus San Mateo County and East Bay MUD.
LIBOR is a set of interest rates that the world's biggest banks use to determine how much it will cost them to get loans from their peers. In terms of its importance to the global economy, LIBOR is second only to the US Federal Reserve's federal-funds rate. It's used to determine everything from home mortgage rates and auto loans to the obscure universe of financial products called derivatives that involve trillions in debt and assets.
It's this shadowy and mostly unregulated derivatives market where East Bay MUD and other Bay Area governments have been potentially hurt the most. Like all big public agencies, East Bay MUD is a major borrower in the bond market. Many of the bonds East Bay MUD sold over the last decade were based on variable interest rates. To guard against the risk that variable rates would rise to unaffordable levels, East Bay MUD purchased from the banks what was supposed to be a sort of guarantee — a derivative known as an interest rate swap. The swaps were designed to artificially fix the interest rate payments on the bonds so that wild fluctuations wouldn't unexpectedly blow up and eat into East Bay MUD's budget.
Under the terms of nine different swap agreements with East Bay MUD, big banks, including Citibank, JP Morgan Chase, and Bank of America used LIBOR as the benchmark interest rate. But if the banks routinely gamed LIBOR, as East Bay MUD and other local governments allege, it means that the banks illegally reduced the payments they owed to East Bay MUD, forcing the utility to find the money necessary for its debt service payments elsewhere — i.e., its ratepayers, the public.
"The market for LIBOR-based investments or financial instruments is in the hundreds of trillions globally," said Nanci Nishimura, a partner at the Cotchett, Pitre, & McCarthy law firm, which is serving as outside counsel for many local governments pursing LIBOR actions, including East Bay MUD and the City of Richmond. "In California alone, this market is in the hundreds of millions, so potential damage to public entities here because of bank manipulation of LIBOR is in the tens of millions."
US banks on the LIBOR panel, which sets the interest rates, include Citibank, JP Morgan, and Bank of America — the same banks that sold rate swaps to East Bay MUD. Other well-known banks that are believed to have engaged in the conspiracy to rig the LIBOR rate include the Royal Bank of Canada, which sold an interest rate swap to Richmond. Together these financial powerhouses sold thousands of swaps and other LIBOR-linked derivatives to local governments nationwide in the 2000s.
Federal authorities in the US are conducting criminal investigations of these banks because of their role in allegedly rigging LIBOR, as are authorities in the UK, Switzerland, Canada, Japan, and Singapore. Barclays, the Royal Bank of Scotland, and UBS (ranked as the seventh-, eighth-, and twentieth-largest banks in the world, respectively) have already reached settlement agreements with law enforcement authorities, and some are cooperating in further investigations of rate rigging. Official probes have produced much of the evidence that local governments are now using as the basis of civil lawsuits. Under US and California antitrust laws, public agencies can sue for damages equal to three times the amount they lost.
Richmond's lawyers list three specific rate swaps — one with Bear Stearns, and two with the Royal Bank of Canada (RBC) — that appear to have cost the city millions of dollars because of rate-rigging. "Richmond has been playing a leading role in addressing the rigging of LIBOR by big banks," Richmond Mayor Gayle McLaughlin wrote in an email to me. "This has caused harm to our community and others." McLaughlin said that in addition to the lawsuit, Richmond will hold a community study session on the issue on March 26 at City Hall. San Francisco hasn't filed its own lawsuit yet, but does plan to hold public hearings on possible financial harms caused to the city by bank fraud.
"Other public entities ought to be investigating the impact from LIBOR manipulation on their finances," Nishimura said.