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As bank scandal roils London, Mass. taxpayers need answers

While a bank scandal over interest-rate rigging has caused a public outrage in London, there’s also good reason to think Massachusetts public agencies and others in the United States are among those who suffered because of the manipulation of a rate called the LIBOR. Public officials here are right to probe whether taxpayers in Massachusetts have been wronged.

Here are the basics: An English bank, Barclays, has admitted to falsely reporting interest rates that it charged borrowers; by reporting lower rates than it was actually charging, Barclays gave the impression that its loan and investment portfolio was less risky than it really was. Yet the bank’s interest rates also factor into the London Inter-Bank Offered Rate, or LIBOR, which was widely seen as an independent benchmark and is used to set borrowing costs for everything from mortgages to student loans to bonds for public projects. And while suppressed interest rates may have helped some borrowers, manipulation of the LIBOR could mean others overpaid for financial products. Regulators abroad and in the United States are now looking into whether other large banks misreported their rates, too.

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Such manipulation would have a direct effect on Massachusetts, as parts of the Commonwealth’s $10 billion cash portfolio are linked to LIBOR, said state Treasurer Steven Grossman, who has started an investigation with Attorney General Martha Coakley. That’s why any probe should look comprehensively at the effects of interest-rate manipulation on the state.

Policymakers should focus in particular on one LIBOR-linked financial product that’s burdening public coffers: the interest-rate swap, a product that allows borrowers to lock in low rates when interest rates seem likely to rise. The downside is that if rates fall, borrowers end up paying much more ­— and the lower the rates, the more they pay. The Massachusetts Bay Transportation Authority entered into a dozen interest-rate swap deals. Other state agencies and Harvard University entered into such deals as well.

Because LIBOR and other interest rates plummeted during the financial crisis and have stayed low since, the lower-than-expected rates are costing swap holders millions annually — an estimated $26 million a year for the MBTA alone. Refinancing debt at current rates would make sense if not for the costly exit fees written into swap contracts.

Perhaps unknowingly, many banks sold swaps on a false premise — that interest rates would move independently, in line with the market. But there may be an upside: If an investigation turns up widespread manipulation, public officials would have a stronger case to get out of these onerous interest-rate swaps and recoup damages that taxpayers suffered as a result.

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