Barometer of Fear

by Alexis; Stenfors

  ‘Don’t worry,’ I was told. ‘We can always suggest a cleaning job in Hokkaido.’

  I understood. Giving the trader the option of moving to another island of Japan would mean that the bank, technically speaking, still required the employee’s services. However, given that it would mean being humiliated in front of family and friends, the trader would never exercise that option.

  I did my duty.

  Afterwards, some colleagues jokingly began to call me ‘The Axeman’. I hated the nickname, but thankfully did not have to perform any more such executions. Money probably does have a tendency to drive out morality.2 However, where do you draw the line between the morals of society and the morals of the market? Where do you draw the line between the morals of the bank and the morals you hold yourself? Should any such line be drawn at all?

  ***

  Over time, the financial crisis made me feel more and more disillusioned. I began to feel uneasy about Merrill Lynch, particularly in the run-up to the takeover by Bank of America. I began to feel uncomfortable with the market as a whole – not only with LIBOR but also with the erosion of a range of trading principles. The camaraderie and mutual respect that I felt had once existed in the market had been replaced by a ruthless, backstabbing mentality. This was probably due to the desperation traders and banks felt about having to make money – or not lose it. Part of my disillusionment was reflected in how I felt physically. I tried to address this by going to see the company nurse, and also my GP. Prescription drugs could ease some of the pain I felt in my ribs, stomach and right arm, but in reality my attempts to deal with the situation were half-hearted. Subconsciously, I think I was keen to be taken off the pitch, but in reality I was shouting: ‘I want to play, I want to play!’

  I should have told my manager sooner. But I did not trust him. I should have alerted the FSA to the concerns I had about myself, about the bank, about the industry and about the market. But communication with the regulator was supposed to be done at the bank, not trader, level. I should have been more persistent when talking to central bankers. But they did not seem to understand. I should, perhaps, have contacted the media. But a confidentiality agreement prevented me from doing so. I should have resigned. But the loyalty I felt – however misguided – was too strong. On Friday 13 February 2009, which was to be my last day as a trader, I left the office to go on holiday with no concerns.

  ***

  ‘When I make this phone call, it will be the end of my banking career,’ I told Maria before I dialled my manager four days later.

  ‘It’s the right thing to do,’ she said. ‘You’ve got us.’

  I realised I had made a huge mistake and needed to act immediately. I also knew that, no matter how horrible the next chapter in my life would be, there was no going back. I did not want to go back. The manner in which my manager had responded led me to contact a lawyer, well knowing that this was exactly the thing I was not supposed to do. De facto, it meant that I had betrayed the bank, and it was going to be me versus them. I was under no illusion that the blame would fall on me once the internal investigation had been concluded and passed on to the regulators. At the time, few would argue that the management, the bank, the market or the financial system had anything to do with the problems I had caused. Judging from the emails, voicemails and text messages I got during this period, though, the scale of what I had done took colleagues and people in the market by surprise. I was told that someone higher up at Merrill Lynch said that mismarking amounting to $40 million or $50 million would be ‘OK’ given my strong reputation. Others warned that my trading book was being plundered, or dumped in the market, while I was away. They knew how incredibly difficult, and expensive, it would be to close such an enormous trading book. Quite a few also expressed sympathy and argued that I had been made a scapegoat for a rotten banking system. I think they wanted to avoid the unpleasant thought that I actually had done something wrong. The strange thing was that, even though my reputation was in tatters, I felt surprisingly confident that I had made the right decision.

  ‘If you are dealing with a regulator, the best approach is always to co-operate, if you can,’ Ian, my lawyer, told me emotionlessly later the same day. Even though he supported and defended me throughout the case, it never occurred to me that I could have opted for a different route – one that emphasised the guilt of others. Yes, the situation was complex and there were many misunderstandings to be cleared up, but arguing for complete innocence was nonsensical. And regardless of the outcome, I still had to deal with my own sense of guilt. I felt guilt towards Merrill Lynch. I felt it towards colleagues and other traders, brokers and clients in the market. I felt guilt towards Maria and my children who had to live through the aftermath of my actions. It was my fault that some neighbours and parents in the schoolyard suddenly began to avoid us. Without me, journalists would not have harassed relatives and old school friends. Beyond this, there was a seemingly endless list of people I had never met who argued that I also owed them an apology.

  After a year of discussing morality with a lawyer, two years with a psychotherapist, and several more years talking about it with people I have met since, I am not sure whether I have come any closer to a definitive answer to the question ‘Why did you do it?’ Perhaps getting an answer was always less important than seeking an answer.

  CHAPTER 3

  SUPERHEROES AND BEAUTY PAGEANTS

  For a derivatives trader such as myself, being able to accurately predict future LIBORs was as difficult as trying to solve a Rubik’s Cube for the first time.

  There were so many things that had to be taken into account when working out what the next move by the central bankers was going to be, and how many of these potential decisions had already been anticipated by the market (and by how much). Central bankers were mostly concerned about ensuring that the inflation rate reached a certain target. However, this target was set at some point in the future. A number of important variables could influence it, such as the employment rate, retail sales, household consumption or the exchange rate. Moreover – and especially during times of financial instability – liquidity risk and credit risk also mattered, as well as how these risks developed over time.

  Because you could not look into the future, LIBOR was a puzzle that could never be solved completely. Anything might happen right up until LIBOR was published around noon. Some days you might get very close, or even be spot on. But then, after lunch, the matrix would have been rearranged and you had to start all over again.

  In 2008, I was actively trading derivatives linked to eight IBORs: the Japanese yen TIBOR, the Japanese yen LIBOR, the US dollar LIBOR, the Swiss franc LIBOR, the euro EURIBOR, the Norwegian NIBOR, the Swedish STIBOR and the Danish CIBOR. Each benchmark had around ten different maturities: for example, for the one-week LIBOR, banks supposedly lent to each other for one week; on the one-month LIBOR, banks lent to each other for one month, and so on. Most derivatives contracts were indexed against the three-month LIBOR, but there was also substantial activity in the one-month, six-month and in some currencies even the 12-month LIBOR. With eight benchmarks and, say, four maturities, it meant keeping an eye on around 32 different LIBOR fixings per day. Almost all my trading related to financial instruments maturing within three years, approximately 750 business days, from now. That meant potentially being exposed to up to 24,000 future LIBOR fixings at each moment in time. In reality, it was much fewer – probably a few thousand. However, if I changed my opinion about these future LIBORs every day, every hour or sometimes every minute or second (which I often did), it meant having to process millions of LIBOR opinions every single year. For me, it was one of the most stimulating parts of the job.

  It should therefore not come as a surprise that the future LIBOR became a popular conversation topic when I met up with traders at other banks, but also with brokers, hedge funds and multinational corporations that were active in the same markets as I was. LIBOR was something we had in common. Not everyone shared my tas
te in indie and Goth music, and not everyone was interested in football statistics. But everyone could at least have a decent conversation about LIBOR. It often became a route into discussions about the inflation rate, the voting intention of central bankers, the market psychology, and unqualified gossip about who was buying and who was selling, or who was hiring and who was firing.

  ***

  ‘I used to dream about LIBORs,’ Tom Hayes said in an interview with the SFO in 2013.

  I remember that I also used to have dreams about LIBORs and sometimes even nightmares. For better or for worse, however, I cannot recall any of them. I also used to think about LIBORs when going out for a run. There is a place between two houses in the Swedish countryside that, for some reason, still makes me think about the LIBOR fixing for the next International Monetary Market (IMM) date. Of all the potential three-month LIBORs in the future, there are certain dates that are especially significant: the so-called IMM dates. These are standardised dates each quarter when a large proportion of derivatives contracts are settled.

  A market maker at a competing bank once called me up after having paid a visit to IKEA. He had found no free parking slots on a Sunday morning. The surprisingly strong demand for flat-packed furniture on a Sunday morning, he argued excitedly, surely meant that the retail sales figure would go up next month. This, in turn, would lead to higher prices and thus meant that the risk of inflation had increased overall. He wanted to share this anecdotal evidence with me, as it obviously had a direct impact on the future NIBOR; this was because the central bank watched the level of inflation like a hawk. He also told me that he had traded some derivatives on Monday morning, based on this information he had gathered.

  Other conversations were more mathematical. Some of us would argue for hours about the likely LIBOR on the next IMM date. If a dinner party ended up with a discussion about the next IMM LIBOR fixing, you knew that it had become a guaranteed conversation killer for non-traders. You truly had to be a nerd to be interested.

  For a trader not working for a LIBOR panel bank, or not seated physically close to one of the LIBOR submitters (the traders or other bank staff on the cash or treasury desk responsible for inputting the numbers) – both of which were true in my case – the benchmark also became a daily source of irritation. The LIBOR fixing sometimes appeared to be deliberately skewed in one direction or the other. Of course, quite often my opinion was biased depending on the position or view I had. It tends to be more common to question the referee’s decision if it goes against the team you support. However, my risk taking had increased substantially over the years, and my attention to the various LIBOR fixings had grown accordingly. Every single basis point mattered immensely. Often, even half or a quarter of a basis point could make or ruin a day. In the major currencies, such as US dollars, euros and yen, even an eighth or a sixteenth would be significant. The bigger my bets were, the more nervous I became of the outcome.

  I can’t remember precisely when I started to become irritated about the LIBOR fixings, or in relation to which currency, but it must have been around 1999. Later, probably around 2001, I had discussions with an important client about the inaccuracy of LIBOR. He was a very active trader, but also a fascinating person to talk to. We often had opposing views about the future LIBOR. However, I had never met anyone with the same passionate interest in that five-letter word, nor anyone who shared my view that the ultimate fixing was sometimes highly questionable. Although I do not recall what was said, we did talk about the fact that LIBOR sometimes could be ‘wrong’.

  I became increasingly frustrated by this incorrectness, which somehow seemed to have become systematic, often around IMM dates – this was particularly true with regard to NIBOR. The market was relatively small, and you could count the number of NIBOR banks on your fingers. I had grown into a rather big fish in the small Norwegian derivatives pond, and I was placing massive bets on the NIBOR rate. The problem was that when I ‘wanted’ a high NIBOR, it sometimes – and for no apparent reason – fell on the day when the relevant fixing took place and then rose back again the day after. But by then it was too late. The opposite often happened when I was betting on a low NIBOR; a group of panel banks then managed to push it higher.

  I decided to call the trader with whom I had spoken in 2001 and ask him whether he had had the same experience.

  ‘Occasionally,’ he said, without any particular passion.

  But on an IMM date a few months later, he phoned me to ask whether I had seen that day’s NIBOR fixing.

  ‘Yes, of course,’ I replied.

  ‘It’s an outrage!’ he shouted back, correctly pointing out that it had dropped several basis points from the day before – seemingly out of the blue and without any reason.

  I decided to call a trader at one of the Norwegian panel banks to ask what was going on.

  ‘The thing is,’ he said indifferently, ‘the large fixing banks skew the fixing depending on their FRA positions.’

  ‘So what can you do about it?’ I asked.

  ‘Nothing, but I’ll give you a hint. The small panel banks don’t carry any risk up until the fixing. If you call them a few minutes before the fixing and sell them a fraction of the position you have, they won’t have time to get out of it before they submit their NIBOR quotes. They will set them high.’

  He was explaining that the larger panel banks had an incentive to skew the fixing in one direction or the other, and that they did so systematically. There was nothing in it for the smaller banks, however, as they did not take much risk. Small panel banks were invariably also small market makers, which meant that they had less client flow as well as a less aggressive risk-taking culture. All in all, there was less reason for them to skew the fixings as they had smaller positions. Thus, his suggestion was that I should sell some of my positions to them just before fixing. A gentlemen’s agreement stipulated that all market makers, and the panel banks especially, were required to quote bids and offers in FRAs until shortly before they expired, after which the fixing took place. By selling to them if I were ‘long’ (or buying from them if I were ‘short’), the smaller banks would end up long (or short) as well. By leaving it until the very last minute, they would not be able to pass on the FRAs to anyone else in the market, ultimately leaving them with a similar position to mine – albeit on a smaller scale. If they were greedy, they would try to manipulate the fixing in their own favour, which obviously would suit me too. They would be playing on my team, so to speak.

  I did not like it. It was basically like forcing someone, against their will, to become an accomplice. The fixing process was just a game that was played among the panel banks, and the rules had now been explained to me. I could not change the rules. However, it was obvious that I had been taking far too much risk in the run-up to the NIBOR fixing dates. I had to be more diligent and did some calculations back and forth. In the end, I came up with a number showing the maximum derivatives exposure I could have ahead of any specific NIBOR fixing.

  I cannot remember how I worked it out, but the number was 27 billion Norwegian kroner, or about $3 billion. If I had more than that, it was almost certain that a majority of the panel banks would want the opposite fixing from the one that would suit my trading book. Despite the phenomenally large amount, the number of banks involved was small. Every player had significant power to influence the market. But some also had the power to influence the NIBOR fixing. There was no doubt that the NIBOR fixing banks would take advantage of the situation. I would be slaughtered.

  ***

  When Barclays was fined £59.5 million by the FSA and $360 million by US regulators in June 2012, I read the released transcripts with a mix of academic curiosity and outright anger. At the time, I was still trying to come to terms with my own guilt from my case in 2009. I knew there was a problem with the LIBOR ‘system’, but for some reason I repressed the thought that human beings other than myself were at fault. Having lost patience with my endless monologues about LIBOR, TIBOR, ST
IBOR, NIBOR and EURIBOR, Maria said to me: ‘You keep on assuming you’re the only person in the market who’s done something wrong. You’ve been so busy carrying around your own guilt that you can’t see how the system has manipulated everybody. Stop assuming that you are the bad guy all the time. Accept that everybody is guilty.’

  According to the FSA, Barclays had made ‘submissions which formed part of the LIBOR and EURIBOR setting process that took into account requests from Barclays’ interest rate derivatives traders. These trades were motivated by profit and sought to benefit Barclays’ trading positions.’1

  This statement echoed a sentence in my PhD proposal from April 2009, where I claimed: ‘Setting a LIBOR that creates a profit for the underlying derivatives makes economic sense.’ I had tried to sound cynical but objective about the market. At the time, though, it had never occurred to me that LIBOR would ever become a ‘scandal’.

  The revelations caused public outrage in the UK. Marcus Agius resigned from his position as Chairman of Barclays, as did Chief Executive Bob Diamond and Chief Operating Officer Jerry del Missier. The media appeared keen to recite the potentially incriminating and often outrageous conversations between the individuals whom the regulators had decided to keep anonymous – and in each case I instinctively tried to work out who they were referring to. Who were ‘Trader A’, ‘Trader B’ and ‘Trader C’? Did I know ‘Broker D’? All of them had been active in exactly the same markets as me. All of them had been working for banks and interdealer brokerage firms that I had traded with on a daily basis for years.

  Maria was tired of my naivety, and thought I should have the mental strength to see reality for what it was, or at least what it had become. Effectively, she wanted me to stop acting like I was the only black sheep in the industry when clearly this was far from the case.

  True, I no longer needed the same kind of survival mechanism as I had when working in the industry or even throughout my case in 2009. Still, I wasn’t totally convinced by Maria’s argument that I wasn’t uniquely culpable. I did not want revenge. I did not want to know who had rigged LIBORs against me. Somehow, I found it easier to come to terms with my own mistakes without them. Still, I have to admit that I also felt a great deal of anger, and that some of this anger was purely personal. I had spent 15 years trying to predict the various LIBORs. But an ability to predict LIBOR is not the same as a privilege to determine LIBOR. These banks traded trillions of LIBOR derivatives, pretending that they were trying to predict LIBOR like anyone else while secretly rigging it in their favour. How could I have been fooled by so many for such a long time? I made a conscious decision not to get involved in actively trying to figure out the identities of the LIBOR manipulators. Instead, I would stick to my original plan and focus on the academic work. A personal narrative could wait.