Libor Scandal Explained

by Darwin on July 15, 2012

The LIBOR Scandal has been getting quite a bit of press over the past few weeks as the web of investigations, settlements and accusations continues to grow.  In a nutshell, LIBOR is the London Interbank Offered Rate which is supposed to be representative of what the borrowing costs of leading banks in London when borrowing from other multinational banks.  The rate accounts for various currencies and banks and is supposed to be broad enough and random enough in its sample size to avoid manipulation. Evidently, it wasn’t.  The most prominent recent scandal involved Barclays bank in which criminal settlements ensued and other large banks were ensnared in accusations of helping to perpetrate the fraud.

Why Does LIBOR Matter?

Well, it appears as though the majority of the manipulation was in reporting artificially LOW LIBOR rates.  Why would a bank do that?  Leading into the financial crisis, people were freaking out over the portending collapse of the entire financial system and some banks stopped lending to each other completely.  A side effect of a lack of lending and liquidity would be much higher rates for those lending to compensate for higher perceived risk.  In order to assuage markets and not cause further deterioration, banks had pressure to make outward appearances of confidence, so by reporting lower LIBOR rates, they would not draw scrutiny to potential solvency issues, with bank runs and stock selloffs ensuring.  So, you’d think that artificially low reported rates would only serve to benefit consumers, right?

Apparently, there were others impacted though and some reports were higher than normal.  So, it will probably be next to impossible to ever nail down that any one individual or even a large entity was ever materially impacted, but I suppose if there are millions of transactions a day around the world, even if a rate was manipulated by a few basis points, it could sum to several Billions of dollars (some even say Trillions) in net impact over the years from a “fair” basis if no manipulation had occurred.  Some of the institutions assumed to have been impacted would have been mortgage lenders, credit card companies, and many financial derivatives.  Chances are though, a typical retail consumer wouldn’t notice a difference of a few basis points, nor would a typical buyer of a CD or typical recipients of secured loans.

This scandal is just going to be another nail in the coffin for those seeking to minimize regulation of Wall Street and another rallying cry of politicians and pundits looking to fry the financial industry.  The lack of credibility is really going to hurt any efforts to curtail costly new policies and procedures and oversight for the industry.  In the end, consumers probably weren’t impacted to a degree that they’d even notice nor is there any reason to think they will be in the future now that the microscope will be on LIBOR rates for years to come.

{ 1 comment… read it below or add one }

Tony @ A Young Investor July 19, 2012 at 7:31 am

These financial institutions…. one thing after another. I bet you there’s a lot more dirty stuff going on, it’s just that we haven’t figured them out.


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