Manipulation of the London interbank offered rate cost issuers in the $3.7 trillion municipal-bond market at least $6 billion, according Peter Shapiro, managing director of Swap Financial Group in South Orange, New Jersey. Shapiro, a muni adviser for more than 20 years, specializes in the contracts.

Any taxpayer losses on derivative deals linked to Libor would add to at least $4 billion in payments that localities have already made to unwind backfiring interest-rate swaps sold by Wall Street banks as hedges to cut borrowing costs, data compiled by Bloomberg show.

“This number shows that banks can’t be trusted in this market,” said Marcus Stanley, policy director for Americans for Financial Reform, a Washington group that has pushed for stronger regulation of lenders. “Municipalities would be the group most likely victimized by the abuse of Libor.”

Issuers from New York to California have entered swap agreements, which are bets on the direction of interest rates. They attempted to lower borrowing costs while guarding against increasing rates by exchanging variable-rate loans for fixed ones. The strategy went awry when the Federal Reserve lowered its benchmark rate almost to zero to counter the 18-month recession that began in December 2007.

$500 Billion

Banks sold as much as $500 billion of swaps to municipalities before the credit crisis, according to a report by Randall Dodd, a researcher on the U.S. Financial Crisis Inquiry Commission. Shapiro based his calculation of losses on his estimate that $200 billion of the derivatives were tied to Libor and that banks suppressed the rate by 0.30 percentage points for three years.

Some U.S. municipal interest-rate swap payments were tied to Libor, the basis for more than $300 trillion in securities and loans worldwide, which is supposed to represent what banks pay each other for short-term loans. While traders have said for years that the benchmark was rigged, the suspicions were confirmed in June when Barclays Plc, Britain’s second-biggest lender by assets, paid a record 290 million-pound ($468 million) fine for manipulating the rate.

Raised Cost

Three-month dollar Libor, the most commonly used of the rates overseen by the British Bankers’ Association, was at 0.35025 percent yesterday, down from 0.58250 percent at the start of the year.

In the derivatives market, setting Libor too low raised what issuers had to pay to their swap counterparties. That drove up their costs and boosted the price of ending the arrangements.

Libor losses may spawn “a wave of lawsuits,” said Michael Greenberger, who studies derivatives at the University of Maryland’s law school in Baltimore. He said civil complaints, settlements with more banks, and, possibly, criminal indictments lie ahead.

“Libor was a bid-rigged rate,” said Greenberger. “Almost all interest-rate swaps begin with Libor.”

Five-State Probe

Since the Barclays settlement, governments around the U.S. have started their own probes, including attorneys general of at least five states, including Florida and Connecticut. Jaclyn Falkowski, spokeswoman for Connecticut Attorney General George Jepsen, and Jennifer Meale, spokeswoman for Florida Attorney General Pam Bondi, each confirmed the investigations. They declined to comment further.

“I have a board and they want to know what Libor is doing to us,” Brian Mayhew, chief financial officer of the San Francisco Bay area’s Metropolitan Transportation Commission, which finances roads and bridges, said in an interview.

The Libor investigations have implications for states and cities that are still contending with the fiscal legacy of the recession, which left them grappling with falling tax revenue and rising costs. States have had to deal with combined deficits of more than $500 billion since fiscal 2009, according to the Washington-based Center on Budget & Policy Priorities.

Baltimore, Maryland, and the New Britain Firefighters’ Benefit Fund, a pension for workers in the Connecticut city, had already sued more than a dozen banks before the Barclays settlement, alleging Libor was artificially suppressed as part of a conspiracy.

Rates Diverge

Baltimore claimed that Libor’s divergence from its historical correlation to overnight swaps showed manipulation. Since the financial crisis, the spread between three-month Libor and three-month swap rates has increased by 95 percent, data compiled by Bloomberg show.

Hilary Scherrer, a lawyer for the plaintiffs at Washington- based Hausfeld LLP, didn’t return a phone call seeking comment.

North Carolina is among states waiting for findings from federal investigations into the abuse of Libor, Treasurer Janet Cowell said in a Sept. 28 interview on Bloomberg Television.

“We don’t know what the manipulation was at this point,” Cowell said. “It’s a lot of analytics and data collection.”

Because each swap is unique in its pricing and structure, it is possible that not all issuers were harmed by the Libor rigging.

Libor Theory

“There’s a theory that the Libor manipulation lowered the interest rate we got paid on our swaps,” said Mayhew. “But the inverse of that is it also then lowered what we were paying on the variable-rate debt.”

Mayhew said he doesn’t expect a quick resolution.

“This is one of those things that won’t be solved in court, it won’t be solved by lawsuits,” said Mayhew. “This is going to be a global settlement where whoever is guilty of whatever gets in a room, makes a global settlement, and then that’s it.”

In muni trading last week, the yield on 10-year munis rated AAA dropped about 0.07 percentage point to 1.65 percent, data compiled by Bloomberg show. The index touched 1.63 percent on July 27, the lowest since at least January 2009, when data collection began. The U.S. bond market was closed Monday for the Columbus Day holiday.