View of New York Federal Reserve Bank from Maiden Lane
View of New York Federal Reserve Bank from Maiden Lane Creative Commons

Email and phone communication transcripts released by the Federal Reserve on Friday show an economist with the U.S. central bank, who was told as August 2007 that one of the world's most important interest rates was being manipulated, did not understand that rate.

The revelation may inflame passions surrounding the current scandal about British banking giant Barlcays plc and other major international banks that improperly influenced the London Interbank Offered Rate, more commonly known as LIBOR.

A transcript of an April 11, 2008, phone call between an unidentified employee at a Barclays trading desk in London and Fabiola Ravazzolo, an economist at the New York Fed's Markets Group, appears to show Ravazzolo didn't fully understand what LIBOR is, even as the Barclays employee described to her a fraud in the process by which the rate was set.

The LIBOR scandal has been ubiquitous on financial news pages since early July when Barclays admitted it was acting to artificially lower the LIBOR throughout 2007 and 2008. Barclays was able to do so because the rate is set via a daily survey of 16 large financial institutions, which are supposed to answer truthfully regarding their current borrowing conditions but as the Barclays revelations show, often appeared to do otherwise.

But though the process by which LIBOR is set is a matter of such widespread public knowledge that even many retail bank tellers know about, it appears from the transcript that Ravazzolo, who has an MBA from the City University of London, didn't quite know about the concept.

How reliable is the BBA [British Banker's Association] for instance because you have only sixteen banks?, Ravazzolo asked the Barclays trader, referring to the industry group that began the LIBOR rate-setting process over 30 years ago and still puts it name in front of the proprietary number. Is it the same framework that the EURIBOR so banks they, they just report the the average rate for what they were lending or is it different?

You're supposed to publish, um, the rate at which you could borrow money, the trader responds.

Ah, you borrow, not lending?, Ravazzolo follows up, to which the trader deadpans that that's the definition of LIBOR is actually.

Still unaware that she was asking about one of the most basic building blocks in the multi-trillion dollar money market, Ravazzolo continued: But, did it, did it, did this change recently, was not lending before? To which the trader charitably responded that it changed a while back, not, not recently and not, not in response to, um, the current financial conditions either.

The significance of Ravazollo's lack of knowledge about LIBOR, at the time the communication occurred, is not clear. For one thing, the Fed, which released the transcripts, has not said what Ravazollo's specific duties were as part of the New York Fed Markets Group. This group is charged with monitoring a wide range of markets for the purpose of understanding and reporting on market conditions and market functioning, according to a Fed statement.

Further, her lack of knowledge does not necessarily reflect the degree to which the central bank had a pulse on LIBOR manipulation.

Nevertheless, it is clear that the Fed had been warned, on multiple occasions.

Four other mass distribution emails, all of which appear to come from the same Barclays employee in contact with the central bankers, suggest or simply assert LIBOR manipulation, suggesting the fudged rates were a sign of market stress in a money market with high daily volatility.

Same old boring story, an unknown Barclays employed emailed the Fed and others in September 2011. Our feeling is that libors are again becoming rather unrealistic and do not reflect the true cost of borrowing.

Those emails, as well as a call between Barclays and another Fed Markets Group economist only identified as Peggy, indicate the central bank was fully aware of LIBOR's manipulation but officials such as Peggy remained primarily concerned with whether the commercial banks were having liquidity crunches that could lead to insolvency.

In a December 2011 call between Barclays and Peggy, for example, the central banker continuously asks the trading desk employee what kind of volume was being observed in the market, setting aside comments by the trader that rates were egregious to where they should be.

There's even a wink-wink-nod-nod repartee between the two, as when the trader tells Peggy recent Fed actions to stabilize money markets stopped the bleeding from getting worse, to which Peggy responded, Yeah, that's good, with a Band Aid, yeah, okay.

That level of camaraderie pales in comparison to a later call between a different trader and Ravazzolo, which led off with the trader complimenting Ravazzolo's nice British accent.

The small talk didn't last long. The two began speaking about a fresh public relations problem.

I'm going to be really frank and honest with you. You know, you know we, we went through a period where we were putting in where we really thought we would be able to borrow cash in the interbank market and it was above where everyone else was publishing rates. And the next thing we knew, there was, um, an article in the Financial Times, charting our contributions and comparing it with other banks and inferring that this meant that we had a problem raising cash in the interbank market, the trader explained.

And, um, our share price went down. So it's never supposed to be the prerogative of a, a, money market dealer to affect their company share value. And so we just fit in with the rest of the crowd, if you like. So, we know that we're not posting um, an honest LIBOR. And yet and yet we are doing it, because, um, if we didn't do it draws, um, unwanted attention on ourselves.

Ravazzolo's clearly accepts the explanation.

You have a business and I completely understand the story, ah, but you know, uh, if everybody has got a similar approach so one can also overcome this article on the FT or whatsoever, she tells the trader later in the conversation. It's that you are penalized just because you are honest the way somebody else that is dishonest.

At one point, the central banker did seem to acknowledge somewhat her ignorance on LIBOR, excusing it by the fact that her previous work had been overseeing EONIA, a different benchmark rate used for euro transactions.

You know, I miss a different picture honestly, because I've been mainly focused on the Euro but now on the end of that I completely understand is that you know, I mean, you remember I was in behind EONIA, Ravazzolo states.