With Libor suit, Baltimore reinforces role as banking watchdog

Police wait for protestors to appear at a branch of Barclays Bank in Westminster, central London.

Two huge civil cases led by Baltimore — one that ended last week as the other gained momentum — spotlight City Hall's emerging role as an aggressive watchdog against the misdeeds of multinational banks.

On Thursday, Wells Fargo settled a nationwide suit launched by the city four years ago that alleged the bank discriminated against black and Latino mortgage borrowers.


Baltimore is also the lead plaintiff in a class action suit against a group of financial firms worldwide it accused of conspiring to keep a key interest rate benchmark low — and thereby siphon off money from the city treasury. The case, pending in a New York federal court, drew fresh attention when the British megabank Barclays recently agreed to a related $450 million settlement with regulators.

A succession of Baltimore leaders have brought several class action suits against banks, alleging a range of financial improprieties that ultimately cost taxpayers and residents, making it one of the more activist municipalities in the country.


"They've taken an active approach to policing the public markets," said Bill Carmody, a lead outside attorney on the interest rate case. A lot of municipal plaintiffs want the money but don't want the responsibility of taking control of a case, he said. "They've stepped up to the plate."

Fear of retribution from banks has not scared off Baltimore's leaders, said City Solicitor George A. Nilson.

"It's to the credit of our two mayors that they didn't back off on Wells Fargo and these other suits," said Nilson, applauding Mayor Stephanie Rawlings-Blake and her immediate predecessor Sheila Dixon.

Wells Fargo settled the Baltimore suit and a related one filed by the U.S. Justice Department for $175 million, most of which goes to borrowers allegedly discriminated against. The city was allocated $7.5 million, money that Rawlings-Blake says will be used to assist Baltimore homebuyers.

"It all started here in Baltimore City," said Thomas E. Perez, the U.S. assistant attorney general who heads the Justice Department's civil rights division. He appeared at City Hall with Rawlings-Blake on Thursday to announce the settlement and credited Baltimore for sparking recognition of the role race played in the subprime mortgage scandal.

Though the Wells Fargo settlement was big, the nation — and world — may have a much larger financial stake in Baltimore's interest rate suit, experts say.

"It could be billions. Or tens of billions. Or maybe even more," said Phillip Swagel, professor in international economic policy at the University of Maryland School of Public Policy and a former assistant secretary for economic policy at the U.S. Treasury Department.

Baltimore's share could range from hundreds of thousands of dollars into the millions, Nilson said.


The suit alleges that banks purposefully suppressed the London interbank offered rate — Libor, for short — during the late 2000s.

Libor is a daily average of the interest rates that banks around the world say they use when they're lending to one another. The rate is meant to reflect market conditions, Swagel said.

Set by the British Bankers Association, a trade group the banks report rates to, Libor is tied to the interest rates on trillions of dollars worth of debt, such as home loans and municipal bonds.

In its settlement with British and U.S. regulators, Barclays admitted that it underreported its rate because it made the bank appear more stable.

Baltimore and more than a dozen other plaintiffs, including public and private entities, believe other large banks did the same thing.

The city sued in August because of Libor's relationship to some of Baltimore's bonds, naming banks on the Libor-setting panel, including Bank of America, Barclays and Citibank.


In the early 2000s, during Martin O'Malley's tenure as mayor, Baltimore issued bonds tied to Libor to raise money for parking infrastructure, water utilities and other projects. To entice investors, the bonds paid a floating interest rate — Libor plus an additional percentage. Such floating rates insulate investors from interest rate swings and inflation.

But they can present problems for municipalities with tight budgets. If interest rates shoot up, a municipality would need to find money by either raising revenue or cutting costs to pay more to the bond investors.

"A typical city just cannot afford that uncertainty. That would be deadly. They just cannot take that risk because they live on a thin margin," said Yuval Bar-Or, an adjunct professor at the Johns Hopkins University's Carey Business School.

In order to protect itself, Baltimore executed a contract with a bank that transferred that uncertainty. The city agreed to pay the bank a fixed interest rate and, in return, the bank agreed to pay the amount the city owed investors on the floating-rate bond.

It's called an interest rate swap. In such an arrangement, if the benchmark rate goes up, the city is protected because the bank foots the bill.

Both the city and the bank should anticipate that the floating rate will remain below the fixed rate that the city pays the bank, so the bank can make money.


But if the benchmark rate is lowered artificially, the city loses more money than it should in the swap transaction.

"At the time when the city did the swaps is when they were very sexy, popular. A lot of municipalities participated in those kinds of transactions. … It's not necessarily unique to Baltimore," said Harry Black, who is in his sixth month as Baltimore's finance director.

Black doesn't have any intention of resurrecting floating-to-fixed swaps during his tenure: "My approach is traditional. Traditional plain vanilla."

In its complaint, Baltimore said it had "hundreds of millions of dollars" of interest rate swaps tied to Libor between August 2007 and May 2010, the period during which Baltimore and the other plaintiffs allege that banks suppressed Libor.

In 2008, a key year in the lawsuit, Baltimore had more than a half-billion dollars tied up in Libor-related swaps, according to the city Finance Department's annual report.

That amount is not unusual for a city of Baltimore's size, experts said.


"Large municipalities very likely have these types of exposures," Bar-Or said, and it would only be natural for a city to neutralize its risk by swapping a floating rate with a bank for a fixed interest rate.

Though Baltimore was not the first municipality to file a Libor-related case against banks, the attorneys hired by the city have been designated lead counsel for similar defendants, such as other public entities.

That puts Baltimore at the center of the action, Nilson said.

"Common sense would suggest that being at the table is better than being in the corner of the room or waiting in the anteroom for an outcome," he said.

Baltimore's attorneys were given lead counsel status because the city has a much larger financial interest in the case than the other named municipalities, said U.S. District Judge Naomi Reice Buchwald in her November decision appointing Baltimore's outside counsel, Hausfeld LLP and Susman Godfrey LLP, as interim class counsel for the antitrust litigation.

By representing its class, Baltimore has more control over the course of the litigation, said Carmody, an attorney with Susman Godfrey. If the case settles, which he predicted it will, Baltimore will be able to steer the settlement in its own best interests, he said.


Baltimore has had long-standing relationships with both Hausfeld and Susman, Nilson said. In 2008, the firms filed two federal class action cases on Baltimore's behalf in New York, both similar to the Libor case.

One alleged that banks hid the risk of auction-rate debt — a risky municipal bond that has its interest rate periodically reset at auction — that Baltimore issued in the early and mid-2000s. Baltimore, like many other municipalities, had issued over $100 million of auction-rate debt.

A judge dismissed that case in 2010. But the other case, in which Baltimore and other municipalities allege that banks rigged bids for municipal derivatives, continues. Several banks, including J.P. Morgan Chase & Co., have already settled this litigation.

Defendants have filed motions to dismiss in both the Libor and municipal derivatives cases.

During discussions about the municipal derivatives case, Nilson recalled, the firms brought up the developing Libor rate situation.

After talking over the issue, Nilson said, Baltimore officials decided that the city may have been substantially damaged by an artificially low Libor. The city signed on as a plaintiff.


The upfront cost to Baltimore for cases like the Libor suit is minimal, Nilson said. The outside attorneys work on a contingency fee basis — they get paid only if they win, he said.

Still, despite the low cost and potential returns of class action suits, the city is deliberate about the cases it joins, Nilson said.

For example, Baltimore recently turned down an opportunity to join a product liability case because the city had not purchased enough of the product, he said. The damage to the city just wasn't there, Nilson said.

Nilson and his outside counsel have no doubt Baltimore lost money — money that could have been spent to keep open recreation centers and fire companies — because of Libor rigging.

Carmody expects monetary recovery to be through the roof. "This is going to get real ugly for banks," he said.

Black, the city finance director, is more reserved. He thinks anything the city gets from the case will be negligible compared to the overall budget, which amounted to $2.3 billion in fiscal 2012.


"The money's obviously very important, but what's equally important is the fact that this activity was caught and these institutions are going to be held accountable," Black said.

Swagel, the former Treasury economist, believes it's still an open question as to whether Libor rigging, if it happened, is quantitatively important to a city like Baltimore.

Regardless, if other banks release information during discovery that is as damning as the records released by Barclays, Swagel said he suspects many bank executives could be forced to resign. Barclays' top executives have already stepped down over the scandal.

Late last week, a dozen Democratic U.S. senators called for a criminal investigation of banks involved in the matter, and the Federal Reserve Bank of New York released documents indicating that as early as 2007 regulators there suspected Libor manipulation.

Those documents were released in response to another congressional inquiry, by Rep. Randy Neugebauer, a Texas Republican who chairs the investigations subcommittee of the House Committee on Financial Services.

"The manipulation of Libor is outrageous," Swagel said. "It really goes to the heart of our financial system."