The Spider Network

by David Enrich

  Big providers of financial data were among the entities paying licensing fees to use Libor. So were banks. But the largest, most lucrative clients were those (like the Merc) that were spending lots of time creating new types of derivatives. Those derivatives needed to be based on something, and Libor often seemed like a good bet. Ewan got to work expanding the menu of Libor varieties and licensing out the benchmark for use in what he called an array of “novel derivatives.” Within a few years, he would boast that he had managed to quadruple the money that the BBA was making from Libor. Products like interest-rate swaps now increasingly relied on Libor as the basis for the floating-rate segment of the transaction (the one in which Giantbank would agree to pay interest to ABC Corp.).

  Ewan, however, didn’t see Libor as ultimately being his responsibility. In fact, he didn’t see it as even being the BBA’s responsibility. That might seem odd, but it was a fiction that had been passed down over the years, long predating Ewan’s arrival. The BBA insisted that policing Libor, to the extent that it needed to be policed at all, was the responsibility of an obscure assemblage of midlevel British bankers called the Foreign Exchange and Money Markets Committee. The purpose of the FXMMC, the tongue-tying acronym that its members used as shorthand, was to discuss issues relating to London’s foreign-exchange and cash markets. The committee’s members worked for dozens of large banks, most wallowing in unglamorous departments that specialized in moving money back and forth among different internal units of their companies.

  The committee itself was something of an old boys’ club. At its meetings, generally attended by about twenty people seated around a large rectangular conference room in the BBA’s underground boardroom, members would politely form a consensus. The committee never actually voted on anything. The sessions rarely lasted more than an hour, partly because the participants weren’t thrilled to be there. Attendees didn’t win any points within their own institutions for showing up—it was just part of the job, and a dull one at that. Citigroup’s representative on the committee, a bald, plump, by-the-books man named Andrew Thursfield, tended to arrive at the very last minute and to rush for the exit as soon as the meetings adjourned. Occasionally, especially around the holiday season, the group would adjourn to a nearby pub. Even those outings were brief; most participants stuck around for only a half hour. Indeed, the committee’s members would turn out to be more concerned with minimizing their time commitments and protecting their respective banks than they would be about trying to deal with Libor’s increasingly obvious problems.

  * * *

  Each spring, Ewan and Merriman or another colleague fanned out across the City of London and Canary Wharf to check in with the banks about how they thought Libor was working. As far back as 2005, around the time that Ewan started his job, the BBA had been hearing scattered complaints about Libor’s integrity. That year, Barclays was the main dissenter. Its concern was that Libor was too high; banks seemed to be reporting data that overstated their borrowing costs. (An exaggerated Libor would result in them making more money off their loans to individuals and companies.) Barclays, however, wasn’t thrilled with the situation; perhaps its traders had amassed positions that would profit if Libor moved lower. In any case, it was alone in sounding the alarm, though the proud British institution, with its Quaker roots tracing back to 1690, wasn’t in a great place to be casting aspersions—some other banks privately had voiced concerns to the BBA that Barclays was itself manipulating Libor to suit its own interests.

  By 2006, Barclays’s concerns had faded. In fact, the feedback the BBA received that spring was overwhelmingly positive. Everyone seemed happy. “It’s not broken. Don’t try to fix it” was the concise appraisal from Citigroup’s Thursfield. The same was true in the spring of 2007. One bank after another gave Libor an enthusiastic thumbs-up. When Ewan visited Deutsche Bank’s offices, in a building across the street from the ruins of the London Wall, which Romans had built two millennia ago, a bombastic Canadian executive named David Nicholls expressed “complete satisfaction” with the benchmark. Officials at France’s two biggest banks lauded Libor’s accuracy and said it seemed to be getting more reliable over time. J.P. Morgan’s representative assured Ewan that there weren’t any signs of the rate being manipulated. And when Ewan showed up at Barclays’s Canary Wharf skyscraper, adorned with its prominent blue-eagle logo, he was greeted with still more good news. An executive, Miles Storey, told him that the bank thought Libor was “currently at peak performance.” Storey also happily noted that the nasty rumors about Barclays manipulating the benchmark “seem to have now subsided.” Storey wanted to make one thing abundantly clear: Barclays had not been manipulating anything, ever. In any case, he observed with a smidgen of condescension, there really was no way for the benchmark to be rigged, given the large number of other banks that would have to be involved in such a conspiracy. It just wasn’t possible.

  * * *

  Some six hundred miles to the southeast of London, Andrew Smith showed up for work at UBS. The bank was headquartered in the center of Zurich, where streetcars glided along cobblestone streets. Smith, however, was based in a satellite office out by the Zurich airport where UBS stashed its fast-growing fleet of traders and math whizzes, as well as the back-office gnomes who processed their transactions and made their systems run. Cows grazed in a field outside. On clear days, the snow-covered Alps could be glimpsed in the distance, peeking above the southern horizon.

  For more than a century, UBS—its name an acronym for its predecessor, the Union Bank of Switzerland—was a conservative lender, not aspiring to anything more than being a trustworthy servant of its mostly Swiss clientele. It was considered the premier place to work in Switzerland. Like (of course) clockwork, bankers were rewarded with promotions every two years. When they reached the rank of vice president, managers got to line their new office with their choice of wood: mahogany, walnut, or pine. But the bank had started to stray from tradition during the last decade of the twentieth century. Enviously watching Wall Street firms, Union Bank embraced practices such as hedge fund investing. In 1997, it merged with Swiss Bank Corporation in a $25 billion deal that made UBS the world’s biggest bank. Swiss Bank’s CEO, Marcel Ospel, had spent years trying to turn the staid institution into a globe-spanning investment bank through acquisitions of derivative firms and investment banks such as Britain’s flagship finance house, the merchant bank S. G. Warburg. Now Ospel became CEO of UBS. He kicked the risk-taking into higher gear.

  Smith, a Brit, hadn’t attended college, having gone straight into banking in 1989, joining a company that would one day be absorbed into UBS. In 2003, he was transferred from London to the Zurich office, where he was a midlevel trader. He was working on what was known in the industry as the cash desk, the part of the trading floor where employees kept their fingers on the pulse of the markets for cash—in other words, the markets that served as one of several outlets for banks like UBS to borrow or loan money from or to other financial institutions. Because of their supposed line of sight into these markets, they were the guys generally responsible for figuring out and then submitting Libor data. That was true not just at UBS but at most banks. Sure enough, one of Smith’s duties upon arriving in Zurich, where he would remain for the next five years, was to handle UBS’s submissions of the British pound, or sterling, version of Libor. It was viewed as an administrative duty, as drudgework. There was a password-protected Excel spreadsheet into which he was supposed to enter data every morning about how much it cost the bank to borrow money from other banks. Then he would hit a “submit” button embedded in the spreadsheet, and off the data went. The system was an upgrade over the phone-it-in approach that the BBA had used in previous years, but it was still clunky and prone to crashing.

  Smith had basically no clue what he was doing. He didn’t know how to go about figuring out the bank’s borrowing costs, which were supposed to be the entire basis of the bank’s Libor data. He didn’t even know whom to talk to internally. So S
mith did what plenty of his peers at other banks were doing: He took a shortcut and spoke to brokers, in this case those at ICAP, Tullett Prebon, and RP Martin—the same firms with whom Smith’s younger colleague, Tom Hayes, was building relationships.

  To be more precise, Smith listened to the brokers. Atop the desk of just about every trader at any major bank anywhere in the world sat a device known as a squawk box. It was essentially a series of open phone lines, connected to other parts of the bank or to outside brokers, and then broadcast over a small, crackling desktop loudspeaker. It was a version of the old trading pit that accommodated the fact that the “pit” was now spread across floors and buildings and entire cities. Smith’s box was linked to brokers who specialized in sterling derivatives, and some of them provided a useful service: In the morning, they would shout over the box where they expected Libor to move that day. So Smith, lacking much other relevant information, would make up his submission based in part on what the brokers were predicting. It was certainly simpler than trying to navigate UBS’s internal bureaucracy. And handling the bank’s Libor submissions was just one of Smith’s duties, not a top priority.

  Brokers weren’t Smith’s only sources. One of the investment bank’s priorities at the time was to improve collaboration between different parts of the company. The idea was to transform UBS into a more efficient, collaborative beast, with everyone aware of what his colleagues were up to and pulling in the same direction. The directive was communicated down the chain of command by a senior manager named Holger Seger, a veteran trader who’d worked at UBS and before that Swiss Bank Corp. since 1990. It might have sounded like a vacuous corporate platitude, but UBS employees, at least some of them, took it seriously. Smith was supposed to coordinate with UBS’s traders who specialized in buying and selling interest-rate swaps, instruments whose values rose and fell based on movements in Libor. Sometimes the swaps traders would lob a request in his direction about where they wanted him to submit the bank’s Libor data that day. Even as a rookie on the desk, he understood what was going on. The traders had big positions whose values hinged in large part on Libor—precisely what Marcy Engel and Richard Ross had warned the CFTC would happen. A lot of money was on the line. So Smith generally followed their requests when it came to what he entered into his spreadsheet. He didn’t see any reason not to.

  Chapter 5

  The Lucky Turnstile

  The bottles of red were $500 each and yet they kept arriving at the table, one after another. The traders at the Tokyo restaurant on this evening in September 2006 could afford the wine without any difficulty, but it struck Tom Hayes as a gratuitous waste of money. “To be honest,” he told a friend the next day, it “felt a bit obscene.” He didn’t even like the taste of the expensive stuff, but someone—Hayes couldn’t remember who, although he suspected it was a particularly over-the-top trader from the French bank BNP Paribas—had felt the need to up the ante.

  Excess was everywhere in the heady days before the financial crisis. Similar to UBS, BNP had started out back in 1848 as a run-of-the-mill French lender, but by now it had become a continent-leaping colossus, dabbling in everything from retail banking in Hawaii to lending money to Greek shipping magnates to trading derivatives in Tokyo. Befitting the bank’s grandeur, in 2000 its top executives set up shop in a converted Parisian mansion that had been the venue for Napoleon Bonaparte’s wedding in 1796. The boom—as well as this boozy evening—would end more squalidly.

  Hayes had been in Tokyo a rough couple of months. There was, of course, the lingering ugliness surrounding his trading in his final weeks at the Royal Bank of Canada, but it seemed like nearly everything else had been a mess, too. After he had spent a few days working in UBS’s office, the human resources department got around to collecting his documentation and realized he didn’t have a work visa, only a tourist one. It therefore was illegal for him to be working in Japan. Hayes was ordered by a distressed HR officer to immediately leave for Seoul, South Korea, and to stay there until his Japanese visa came through. The mix-up didn’t inspire much confidence in UBS.

  When Hayes returned to Tokyo a couple of weeks later, he was lonely. In a leap of faith, Ainsworth had followed him to Japan. She didn’t have a job lined up, but given her expertise in derivatives, she figured she could find a gig at one of the Western banks with big Tokyo offices. First, though, she wanted to get to know Tokyo; before long, she was staying out till five thirty in the morning doing karaoke with her new friends.

  If he was honest about it, Hayes wasn’t thrilled to have Ainsworth around. Their always volatile relationship had soured, and he had come to resent her. After a month or two, Ainsworth landed a job at French bank Crédit Agricole, so she wasn’t going back to England anytime soon. Lacking any circumstantial excuses, his only way to end things would be to break it off himself. But every time he started working up the nerve to have the Talk with her, he was racked with guilt. He couldn’t bring himself to abandon her, especially right after she’d moved nearly six thousand miles to be with him. And so they stuck together.

  Aside from Ainsworth, Hayes didn’t have friends in Tokyo. He didn’t speak the language. He didn’t like the food. He preferred to just head home after work. “Any excuse not to go out is my mantra,” he told a colleague at the time. He met one broker, named Nigel Delmar, who showed him around and helped him find an IKEA and a Western-style burger joint, but that was the extent of his social life. Trying to ease his homesickness, he stocked his kitchen with ground meat, herbs and spices, and a Japanese grain by-product and made his own sausages. He installed a device that allowed him to pipe British and American television shows into his apartment. Now he could watch familiar TV programs while eating his sausages along with baked beans and french fries—a classic, if unhealthy, British meal.

  More assistance soon came from his RP Martin broker, Terry Farr, who flew to Tokyo in September. Farr had asked Hayes what he could bring him from England, and the homesick trader had requested cans of Heinz ravioli and a couple of issues of a soccer magazine called FourFourTwo. Pal that he was, when Farr got off the plane in Tokyo, his suitcase was bulging with canisters of premade beef ravioli.

  Not to be outdone by a competitor, ICAP’s Darrell Read soon paid Hayes a visit. What could he bring? Hayes requested a supply of black garbage bags—they only seemed to sell transparent ones in Tokyo. There was something about black garbage bags that appealed to Hayes, maybe the fact that he didn’t like his trash on display for everyone to see. In any case, Read did as requested.*

  At least money wasn’t a problem: Hayes’s compensation that year amounted to more than $600,000. And UBS paid for his housing expenses—no minor perk in Tokyo’s hyperexpensive real estate market. That left plenty of money for Hayes’s limited extracurricular activities.

  At his desk on the cavernous fifth floor of UBS’s Tokyo skyscraper, with teams of traders clustered together in a cacophony of shouting, Hayes generally dressed in jeans or wrinkled black slacks and a polo shirt or, in the winter, a thin sweater. His clothes were old and worn—except those that had been given to him as gifts. (His brokers loved presenting him with polo shirts embroidered with their corporate logos. Tullett Prebon had started the trend, but ICAP couldn’t bear the thought of its prized client wearing a rival’s clothing and so raised the stakes with ICAP-branded polo shirts with Hayes’s name stitched on the back.) He didn’t always shower and knew he looked like “a tramp.” When he was stressed, which was often, he vigorously scratched his head, sending dandruff flakes fluttering onto his shoulders and desktop and generating an endless series of snow-related jokes from colleagues. Though self-conscious about his appearance, he didn’t do anything to improve it; instead, to the best of his ability, he avoided being seen. Many UBS traders used a videoconferencing system called Avistar to communicate with each other. It was faster than writing e-mails or even typing into the real-time electronic chat programs that were a preferred mode of communicating for traders and brokers, and call
s on the system weren’t recorded, unlike the bank’s normal phone system. Without a paper trail, you could say whatever you wanted without fear of repercussions. But Hayes refused to use Avistar—the combination of his slovenly appearance and his long-standing aversion to eye contact made him hate it. As a result, most of his communication—in writing and over the phone—would be preserved for posterity.

  Hayes’s first task was to build the pricing and risk systems that he would use for his trading—the same kinds of models that he’d designed at RBC, preferably without the errors. Once again, he used Microsoft Excel spreadsheets to craft the programs. The resulting files were massive, consuming hundreds of megabytes of disk space, and they could instantly process ridiculously detailed calculations about the interrelationships between hundreds of variables. Punch a proposed trade into one cell, and another cell would automatically spit out a price at which it would be profitable for UBS to do the trade. Hayes lovingly regarded his intricate models as similar to living organisms in their complexity.

  Hayes reported to Mike Pieri, a sharp, sociable manager who’d made his name at UBS as a successful trader. Immediately after graduating from small, beachfront Bond University on Australia’s Gold Coast, Pieri had started working at a company that would later be merged into the Swiss bank. He hadn’t intended to make a lifelong profession out of banking, figuring it would just be a way station on the path to one day running his own small business. But like many people who reckoned they would muck around in finance for a few years, just long enough to pay off student loans and, perhaps, amass a small nest egg, it didn’t work out that way. Fourteen years later, after stints in Singapore, Australia, Hong Kong, and Tokyo, Pieri was still at UBS. (Along the way, he had married a tall, blond former flight attendant named Donna, whom he had met years earlier at an Australian soccer tournament.)