Risk Wall St will turn on itself after Libor debacle

Wall St, grappling with mounting regulatory probes and investor claims over alleged interest-rate manipulation, may face yet another formidable foe: Itself.

Goldman Sachs and Morgan Stanley are among financial firms that may bring lawsuits against their biggest rivals as regulators on three continents examine whether other banks manipulated the London interbank offered rate, known as Libor, said Bradley Hintz, an analyst with Sanford C. Bernstein & Co.

Even if Goldman Sachs and Morgan Stanley forgo claims on their own behalf, they oversee money-market funds that may be required to pursue restitution for injured clients, he said.

Because Libor is based on submissions from only some of the world's largest banks, the probes threaten to pit firms uninvolved in setting the rate against any implicated in its manipulation, Hintz said.

Libor serves as a benchmark for at least US$360 trillion ($453.5 trillion) in securities.

"This will be a feeding frenzy of sharks," said Hintz, who has served as treasurer of Morgan Stanley and chief financial officer of Lehman Brothers Holdings.

"We're going to have Wall St suing Wall St."

Libor and similar rates are derived by surveying a group of banks daily.

Participating firms are asked how much it would cost them to borrow from one another for 15 different periods in currencies including dollars, euros, yen and Swiss francs.

After a set number of quotes are excluded, those remaining are averaged and published.

Regulators are looking at whether banks made submissions that understated funding costs during the credit crisis or if traders at the firms influenced Libor to boost profits.

A probe by UK and US authorities already has cost Barclays a record £290 million ($569 million) fine and led to the departure of chief executive Robert Diamond.

Traders at Deutsche Bank, HSBC Holdings and Credit Agricole are being examined for possible links to a former Barclays employee, a person with knowledge of the matter said.

UBS, Citigroup, JPMorgan Chase and Credit Suisse are among at least a dozen banks to disclose inquiries.

Goldman Sachs and Morgan Stanley weren't on the list of banks contributing to Libor.

Hintz asked Goldman Sachs chief financial officer David Viniar on a June 17 conference call whether his firm would view itself as an "aggrieved market participant" if rivals fixed the rate.

"We're going to watch this for a while," said Viniar, 57, without elaborating. "Let's just say we're not a provider of Libor, and we'll just leave it at that."

Mary Claire Delaney, a spokeswoman for Morgan Stanley, and Goldman Sachs's Michael DuVally declined to comment on whether their New York-based firms may bring claims. Goldman Sachs, led by chief executive Lloyd Blankfein, 57, and Morgan Stanley, run by chief executive James Gorman, 54, are the fifth and sixth biggest US banks by assets, respectively.

Non-Libor banks could join in class-action lawsuits filed on behalf of a group of companies claiming to be hurt by the rate's manipulation, Hintz said.

Still, they probably wouldn't be the lead plaintiffs and may settle out of court to maintain "cordial relationships", he said.

Goldman Sachs managed US$209 billion in money-market funds at the end of June, and Morgan Stanley managed about US$75 billion at the end of March, regulatory filings show.

Investment funds may be obliged to seek compensation if they believe a manipulated Libor rate harmed investors' returns, Hintz said.

Morgan Stanley analysts including Betsy Graseck assume banks won't sue as that would "exacerbate negative headlines for the overall industry", according to a July 11 note.

Costs from other claims arising from the probe for 11 Libor banks - such as Barclays, Bank of America, Citigroup and JPMorgan - could total US$7.8 billion, the analysts estimated.

Plaintiffs would face difficulties, such as proving how much money they lost, said Roy Smith, a finance professor at New York University's Stern School of Business and a former Goldman Sachs partner.

Because Libor rates excluded some of the highest and lowest estimates, it may be hard to calculate which firms were culpable for influencing the outcome, he said.

Regulators may also have known that banks were fixing Libor and neglected to stop it, which could make a court case yet more complex, Smith said.

UK lawmakers have been questioning Bank of England Governor Mervyn King and his deputy Paul Tucker on their roles in the scandal.

The Federal Reserve Bank of New York has released documents showing it knew Barclays under-reported rates and recommended changes to Libor.

"It makes it even more complicated when the regulators appear to have known about it and not have objected to it, which means it wasn't illegal," Smith said.

"All I can say is, 'Good luck with your lawsuit'."

Banks such as Goldman Sachs and Morgan Stanley would prefer to settle quietly out of court, said James Cox, a securities law professor at Duke University in Durham, North Carolina.

A series of regulatory cases would make it easier for non-Libor firms to support their case, while also increasing the potential payouts, he said.

"In the meantime, everyone's preparing for war."

- Bloomberg