WASHINGTON — Members of the Senate Banking Committee grilled Treasury Secretary Timothy Geithner Thursday about his knowledge of manipulation of the London Interbank Offered Rate, or Libor, and raised concerns about its potential impact on state and local governments that entered into Libor-based swaps.

Sen. Pat Toomey, R-Pa., asked Geithner, who was president and chief executive officer of the Federal Reserve Bank of New York when Libor allegations publicly surfaced in 2008, why he did not use his position to raise greater awareness of potential problem with libor.

Toomey suggested that earlier action could have minimized negative financial impacts that states and localities may have suffered as a result of Libor manipulation.

“There are literally hundreds of municipalities across Pennsylvania that were engaging in interest rate swaps [and] receiving Libor payments,” Toomey said to Geithner.  “And you knew those Libor payments may not be the correct payments.”

Geithner told the committee that he acted appropriately in 2008 after learning about potential Libor problems. He said he raised his concerns with the financial markets working group of then-President George W. Bush, a panel that included the Treasury secretary, and the chairmen of the Federal Reserve Board, Securities and Exchange Commission and the Commodity Futures Trading Commission.

Geithner noted that in the last four years regulators conducted a “far-reaching, complicated, difficult investigation” which led to an agreement last month by British investment bank Barclays to pay $450 million to settle allegations that it manipulated the rate.

He also claimed the Libor allegationswere in “the public domain at the time.”

“The Wall Street Journal did a very good job of reporting concerns. The vulnerability was there for people to see,” he said.

But Toomey questioned why Geithner did not use his influence as head of the New York Fed to raise greater awareness.

“You were aware of this in early 2008, and for the last four years you never ... used the bully pulpit” to warn the American people, Toomey said. “Why did you not use the enormous influence that you have had, both at the Fed and at Treasury, to persuade the financial institutions to adopt a different mechanism that would not be subject to this kind of manipulation?”

Regulators are still investigating whether other major international banks colluded to keep Libor short-term borrowing rates artificially low.

If they did, municipal bond issuers may have received artificially low Libor-based swap payments and may have paid more to terminate swap agreements.

Industry sources have estimated that municipal issuers have between $50 billion and $100 billion in Libor-related transactions, most tied to the one-month Libor rate.

Sam Gruer, managing director at Millburn, N.J.-based Cityview Capital Solutions LLC., said determining the financial impact states and localities may have suffered remains uncertain, partly because the extent of the manipulation is largely unknown.

If short-term Libor rates were artificially lower, its unclear how that would impact 10-, 20-, and 30-year rates, which are the basis for the valuations and termination amounts of swap agreements, said Gruer.

“The real question is, what’s the magnitude of the manipulation. Was it a handful of basis points or hundreds of basis points, and over what time?” he said.

Gruer said determining the impact will take “a lot of forensics and theory,” and will likely require that enforcement agencies subpoena financial firms to determine the actual rates at which they received financing.

Only then, he said, could municipalities begin to calculate losses.

Jeffrey Gribb, director of the office of special investigations for Pennsylvania auditor general Jack Wagner, called allegations of Libor manipulation “one more reason why [swaps and derivatives] are not appropriate investments for municipalities.”

In 2009, Wagner’s office asked the Pennsylvania general assembly to ban the use of swaps by municipalities following a report in which Wagner’s office found that the use of swaps caused the Bethlehem Area School District to lose at least $10.2 million of taxpayers’ money.

Gribb called swaps and derivatives complicated instruments that are largely understood only by the “people who sell” them.

“The social utility of swaps and derivatives for municipalities is negligible,” he said.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.