BALTIMORE, Md.--For all Baltimore's average citizens knew prior to late June, LIBOR was a faraway planet or some kind of a cleaning compound (as in: "For maximum results, add a dash of LIBOR to your borax when laundering horse blankets").
Then the news broke that British bank Barclays had admitted to gaming a key financial benchmark, LIBOR--the London Interbank Offered Rate--so that its derivatives traders could extract illegal profits for the bank. Barclays is paying at least $450 million in penalties for the scheme, which may have affected mortgages, car financing and student loans.
LIBOR, like the much more widely known prime rate, Baltimoreans learned, is an interest rate to which not just adjustable rate loans but also pension funds and municipal bonds are pegged.
LIBOR-rate manipulations have by now grown far beyond a scandal du jour, prompting multiple investigations involving some two-dozen banks on three continents with potential damages in the billions of dollars.
Lost Money Equals Closed Services
And the banks that set the rate are now the subject of a class-action suit by multiple plaintiffs, led by the City of Baltimore, an urban center that has been struggling to make ends meet. For the past three fiscal cycles -- including the one that began on July 1 -- the city has grappled with multimillion-dollar deficits.
The city's fiscal managers have been forced to take extreme measures, from forcing city employees to take unpaid furloughs to making drastic changes in the city's public-employee pension system to cutting off funds for the historic Poe House, the family home of Edgar Allan Poe.
In the face of budgetary strife, Mayor Stephanie Rawlings-Blake has taken a fighting stance. "We cannot stand by when we feel that we are being cheated," she told CBS-TV. "You're talking about $1 or $2 million. You know, that's a fire company, that's recreation centers. That's services that our city needs, and we're going to fight for that."
Baltimore invested hundreds of millions in "interest-rate swaps," which were devalued by rate-setting banks. Between 2006 and 2009, those "swaps" allegedly kept LIBOR artificially low. The scheme was ordered by bank managers to suggest that their banks were, during a time of economic troubles, more liquid than they actually were, say attorneys for the plaintiffs.
The result was that Baltimore and a large class of cities, states, pension funds and mutual funds received less than they should have in interest payments from banks. According to one estimate, about three out of four major American cities [http://huff.to/S7d5T8] hold bonds linked to the Libor rate.
Baltimore has not given estimates of its potential losses. "Our basic approach about it is that the question [of damages] is likely to be the subject of discovery in the litigation," said Baltimore City Solicitor George Nilson.
However, other would-be plaintiffs have given ballpark estimates. According to one report, New York's Nassau County estimates that it is out $13 million from swaps related to $600 million in outstanding bonds. By comparison, Baltimore reportedly held $550 million in bonds based on LIBOR interest rates in 2008.
"Billions ands Billions of Dollars"
The LIBOR rate is set daily by a panel of banks coalesced as the British Bankers' Association. LIBOR is theoretically the interest rate that a bank would charge to lend money to another bank for three months (although such loans almost never occur nowadays).
It affects cities like Baltimore when they issue bonds to raise money for infrastructure projects. Investors are offered a floating interest rate -- the LIBOR rate and an additional percentage.
To protect themselves from the sometimes radical ups and downs of market fluctuations, though, tightly budgeted municipalities contract with banks, agreeing to pay a fixed rate in exchange for which the bank pays the floating rate to the city's investors. That's an interest rate swap.
If the interest rate fluctuates upward, the city makes a profit. If it swings downward, the city begins to lose money. In the case involving Baltimore and the banks from which it bought interest swaps, the rate was allegedly manipulated downward by bank-rate setters.
"They [the cities] are not getting the interest they bargained for," said William Carmody, a lead outside attorney representing the plaintiffs. "If they're getting a certain number that's tied to LIBOR and LIBOR is understated, they're not getting all the money they should." He said such rate manipulation is a violation of the Sherman Anti-Trust Act.
Carmody added, "The number of dollars at issue is sort of staggering." When all of the cities, states and other entities holding LIBOR-related interest swaps are taken into account, "the damages sustained could be in the billions and billions of dollars.
The defendants in the lawsuit have declined to talk about the case, though they have moved to have it dismissed on the grounds that, among other things, LIBOR fluctuations cut both ways, with no clear beneficiary or victim of an alleged rate manipulation. Thus, while interest-swap holders may be hurt by a lower rate, the rate could theoretically benefit holders of adjustable rate mortgages.
Nilson said the class-action suit has been in the works for about a year. "We had initial information about what appeared to be occurring [with interest rate manipulations], and we determined that the city had utilized the interest swaps during that period between 2006 and 2009," he explained. "Then we authorized outside counsel to pursue a class-action suit."
The Mayor's Troubles
The administration of Mayor Rawlings-Blake seems to have been beset by troubles since she took office two-and-a-half years ago. She was the City Council president and automatically became the new mayor when Mayor Sheila Dixon resigned as part of a plea agreement to settle charges of perjury and embezzlement.
During Rawlings-Blake's first week in office, Baltimore was struck with two devastating winter storms, dumping four feet of snow on the city. There were subsequent record heat waves, flooding and a tornado that destroyed homes. To wrangle her first budget as mayor in 2010, she had to close a $121 million gap, the largest in decades.
She got through the snowstorms and other weather events unscathed, but the budget process left a few scars, especially after she overhauled the public-safety pension system to save the city some $100 million, prompting protests and a federal lawsuit from fire and police unions.
A native Baltimorean, she is the daughter of a longtime member of the Maryland House of Delegates, Howard "Pete" Rawlings, and a family-practice pediatrician, Nina Rawlings. She was elected on her own merits in 2011.
Rawlings-Blake appears to have thrived under the stresses of the job. In a profile last year in the Baltimore Sun, she was described as "poised, confident and crisply professional, unafraid of making tough decisions" -- qualities she may need in order to counter the vastly endowed banking establishment.
Edmund Newton is a freelance writer in the Washington, D.C., area.