(Adds NY probe, NYFED no comment, additional senator)
By Sarah N. Lynch and Alexandra Alper
WASHINGTON, Oct 2 (Reuters) - Two Senate Republicans on Tuesday slammed Treasury Secretary Timothy Geithner for failing to wean U.S. firms off a key British benchmark interest rate that he knew was being rigged, resulting, the lawmakers said, in costly litigation that hurts American taxpayers.
In a sharply worded letter, Republicans Chuck Grassley and Mark Kirk blamed a "deluge" of lawsuits over the manipulation of the London Interbank Offered Rate (Libor) on Geithner's failure to inform the public, even though he knew of manipulation as president of the New York Federal Reserve in 2008.
Geithner did raise alarms with authorities in Britain, where the rate is set, but did not inform the public when he was leading the New York Fed or as Treasury Secretary.
Grassley said Geithner's decision not to take action to end the dominance of Libor, or at least inform the American public, has contributed to emerging litigation that threatens to clog U.S. courts with multi-billion dollar class action lawsuits and losses on interest rate swaps by local, municipal, and state governments which may also lead to more lawsuits.
This, the senator said, will result in higher taxes or fewer local services for Americans, and put American investors at risk.
Grassley's letter comes as the Justice Department, Commodity Futures Trading Commission and the United Kingdom's Financial Services Authority continue to probe whether banks colluded to manipulate the London interbank offered rate, which underpins trillion of dollars in contracts and loans -- from U.S. mortgages to Japanese interest-rate swaps.
New York and Connecticut state attorneys general announced in July they were also probing possible manipulation.
Currently, Libor is based on banks' assessments of what they expect to be charged rather than measuring actual lending rates.
Barclays Plc was the first bank to settle charges that it manipulated Libor when it agreed in June to pay a $453 million fine. Other banks, including UK-based Royal Bank of Scotland Group Plc and Switzerland's UBS AG , are also being eyed by regulators as the investigation continues.
Geithner's handling of Libor has come under fire by other Republican lawmakers. Earlier this year, the New York Fed released documents requested by the House Financial Services Committee, which showed that as early as August 2007, Barclays told Fed staffers about possible problems with Libor. Geithner, who said he learned of the rigging in 2008, alerted authorities to potential Libor-setting problems.
That committee is continuing to look into the Fed's response to that information.
The Treasury Department and the New York Fed declined immediate comment.
AN AMERICAN BENCHMARK
Grassley and Kirk, echoing regulators, called for the creation of an American benchmark to replace Libor.
"If U.S. investors and borrowers have suffered financial harm from our dependence on an index set in London, they have the right to expect the country's leaders to support better alternatives," they wrote.
CFTC Chairman Gary Gensler has been calling for a revised benchmark that would be based on observable transactions, to limit the opportunity for manipulation.
"The critical thing is that it be based on observable transactions, sufficient so that we don't have misconduct in the setting of these rates," he told Reuters in an interview on Tuesday.
This contrasts with the emphasis in a report last week by Martin Wheatley, a top UK regulator, that emphasized how Libor should be repaired rather than replaced, as this could not be done easily in the near term.
Wheatley, managing director of the Financial Services Authority, mapped out in his report how to improve governance of Libor, taking it out of the hands of the British Bankers Association lobbying group, a step Gensler welcomed.
Wheatley and Gensler will now head an International Organization of Securities Commissions' task force to look for alternatives. It is due to report by next March.
(Reporting By Sarah N. Lynch, Alexandra Alper and Rachelle Younglai; Editing by Tim Dobbyn, Bernard Orr)
Keywords: GRASSLEY LIBOR/