[ by Melanie Gretchen ] The Federal Reserve Banks failed to come up with a solution to the Libor issue, despite ample opportunity, considering it may have known as early as August 2007.  In the spring of 2008, the Fed launched an inquiry with Barclays Plc and shared proposals for reform of the system with British authorities.  Evidence that it didn't work: the bank's payment of $453 million to British and U.S. authorities to settle allegations that it manipulated Libor and the resignation of the firm's CEO Robert Diamond Jr., Chairman Marcus Agius, and COO Jerry Missier. First Signs. Amid "thousands of calls and emails with market participants over a period of many months", beginning in late 2007, "occasional anecdotal reports" came in from Barclays over problems with Libor, a New York Fed spokesman said in a statement. Beginning on August 28, 2007,  Barclays communicated with the Fed twice that day to discuss Libor as credit problems as a result of the U.S. housing bust began to rise, according to documents.  From that time through October 2008, there were another 10 communications between Barclays and the U.S. central bank about Libor submissions, including Libor-related problems during the financial crisis, according to the documents.

"We believe that this chronology shows clearly that our people repeatedly raised with regulators concerns arising from the impact of the credit crisis on LIBOR setting over an extended period."

In addition, the New York Fed discussed problems with the calculation of Libor with British authorities and received feedback from market participants about whether an alternative could be found for Libor, people familiar with the situation said.  Following the release of a paper by the Bank for International Settlements questioning the banks' true borrowing costs and whether banks were reporting accurate rates, Barclays met with Fed officials twice in March-April 2008 to discuss the issue. "Fixing LIBOR" Meeting. On April 28, U.S. Treasury Secretary, Timothy Geithner, then New York Fed President, held a "Fixing LIBOR" meeting between 2:30-3:00 pm on April 28, 2008, to which at least 8 senior Fed staffers were invited.  It was a closed meeting, so we don't know who was there or what was discussed, but probably in attendance was the invited James McAndrews, a Fed economist; 3 months later, he published a July 2008 report questioning whether Libor was manipulated and whether a government liquidity facility was helping ease pressure in the interbank lending market.

"A problem of focusing on the Libor is that the banks in the Libor panel are suspected to under-report the borrowing costs during the period of recent credit crunch."

What we do have is a 2010 draft of paper by the Fed, which said that banks appeared to be paying higher rates to borrow from other banks during the financial crisis compared with the levels they reported. What the Fed Could Have Done. To address the issue, the Fed could have embedded its staff in the Libor calculation process, according to Andrew Verstein, an associate research scholar at Yale University.  This would have enabled them to use the Fedwire Funds Service - an electronic system through which banks settle interbank loans between one another - to measure whether banks were accurately reporting borrowing costs. Later, after the financial crisis had passed, regulators could have helped "urge on a newer and better system," he said. The Reality of the Situation. Instead, no regulator was responsible for ensuring that rates banks submitted were honest.  Since the Barclays settlement, documents have come to light that shows Barclays traders on a New York derivatives desk asked another Barclays desk in London to manipulate Libor to benefit trading positions, according to the CFTC.

"For Monday we are very long 3m (three-month) cash here in NY and would like the setting to be set as low as possible." -- A New York trader, in an e-mail in 2006 to a person responsible for setting Barclays rates.

Darrell Duffie, a Stanford University finance professor who has tracked the Libor issue for several years, said that he believed regulators negligent, despite being "on the case reasonably quickly" after questions surfaced in 2008.

"It appears that some regulators, at least at the New York Fed, indeed knew there was a problem at that time.  New York Fed staff have subsequently presented some very good research on the likely level of distortions in Libor reporting.  I am surprised, however, that the various regulators in the U.S. and UK took this long to identify and act on the misbehavior."

CI Note: How many is Darrell Duffie's "several years"?  Considering the New York trader's e-mail was sent in 2006, how much further does the culture of Libor manipulation reach?  Is the Fed smarter now or should everyone else become smarter? For further details, go to [Reuters, 7/10/12].