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The LIBOR Scandal



LIBOR has an influence on interest rates around the world; but recently there have been some questions raised about the rigging of interest rates. Barclays already had to pay over $45 million in fines and it looks like there may be many more fines, and possibly lawsuits to come. Many say that regulators should impose more fines on some of the other 16 banks that are members of the British Bankers Association in hopes that there will never be a repeat.

LIBOR is the London Interbank Offered Rate which is the rate which these 16 banks charge one another for short term deposits and loans. This rate becomes a benchmark for interest rates set worldwide. It influences literally hundreds of trillions of dollars. LIBOR has an influence on various financial contracts corporate loans such as those managed by companies such as Effi Enterprises, interest rate swaps and floating rate mortgages.

Presently, there is much talk about criminal charges and possible jail terms for those involved. Asia, Europe, Canada and the US are investigating what looks like a huge picture of deceit and avarice. Banks must submit their data to be used in calculating the LIBOR; but in order to hide their own institution’s financial problems, or to boost profits for traders, they have submitted falsified data. Remember, that the LIBOR influences interest rates around the world so the repercussions of these devious acts are felt worldwide. Because it affects interest rates, investment firms like Effi Enterprises have been affected by the lowered benchmark.

Lawsuits are pending but as they are pursued they can mean global financial disaster. Municipal governments and investment firms purchased bonds or have entered into financial contracts which were based on LIBOR. They are now asking for compensation from the banks since they intentionally manipulated the benchmark. If the suits take place as it is assumed they will we are talking about potentially tens of billions of dollars that will have to be paid out.

Just so we understand how large of an impact this could have let’s say that LIBOR was only 0.1 percent off for one year. In that time the incongruity on the $300 trillion of swaps could easily mean that the rates were off by up to about $300 billion. This is just one type of contract; it doesn’t even take into account all the other types of contracts or any punitive damages that might be sought. It’s big enough the entire banking system could be crippled.

One suggested option would be for the banks to set up a compensation fund for the victims of LIBOR so that all the banks could pool resources to pay out. An administrator would need to be independent but he could generate a transparent formula which could estimate and calculate the damages that have been done. If the banks at least attempt to right the wrong clients might be more willing to settle instead of pursuing litigation which would be much more costly.

Of course this would take much cooperation among these banks. They would need to decide how much LIBOR had been skewed because of the misreports. Then they would also have to decide how much of the financial liability each bank should be responsible for. Government involvement could help to expedite the process. There may be more regulations set by governments which could help improve the bank’s transparency. Had they maintained transparency this would have never happened in the first place. Perhaps this is a lesson for all of those who deal with financial institutions. Consumers and businesses can benefit from open and honest transparency.

What is LIBOR?

Barclays Bank

Barclays Bank

LIBOR is an acronym for London Interbank Offered Rate. It is basically an interest rate used on the federal level. It’s the interest rate that is charged between banks for loans. As far as interest rates it is the busiest in the world of finance. There are a number of banks which participate in the money market in London and they offer short term deposits to each other. LIBOR is what is used to determine the price of several other financial derivatives. These include items such as futures for interest rates, Eurodollars and swaps. This is very influential throughout the world of finance as it affects more than just the Pound Sterling. It is also important to other currencies like the US Dollar, Canadian Dollar, Japanese Yen and the Swiss Franc.

Every morning in London at 11:00 am LIBOR is set. The exact rate is found by averaging the various interest rates which are being offered by the banks in membership with the British Bankers Association. It is calculated for different time frames from as short as a day to a full year. The banks may offer varying rates throughout each day but the rate set is fixed for a 24 hour time frame. Even when the instantaneous rate and LIBOR are different it is a very small increment and for a short time.

Eurodollar futures are the most important of the derivatives which are related to LIBOR. Eurodollars are basically US monies which are deposited in banks which are outside the United States, generally in Europe. These Eurodollars are traded in Chicago at the Chicago Mercantile Exchange. Depositors outside the country are not subjected to the margin requirements enforced by the Federal Reserve which gives the depositor more leverage over the funds. LIBOR determines the interest rate which is paid on these Eurodollars and these futures provide ways to bet or hedge against the changes in the future interest rate.

There are 16 member banks in the British Bankers Association and they control the rates on about $360 trillion worth in the financial markets and products around the world. This includes the adjustable rate mortgages (ARM), which is where it affects the average Joe. When the interest rates are stable it provides several decent options for those wishing to purchase homes. For these mortgages it means no negative amortization and usually there are fair rates in terms of repayment. Usually the ARM is guided by the 6 month LIBOR plus somewhere between 2 and 3 percent.

LIBOR’s influence affects more than just the homeowner it also affects the entrepreneur and loans for small businesses, students and credit cards. It is all good while the economic climate is stable and LIBOR is doing well. But when economic uncertainty looms, particularly in the developed countries then the rates become volatile. This makes it more difficult for the banks to exchange loans among themselves. This in turn makes it more difficult for others to obtain bank loans. The trouble is that when the system is volatile the bank simply raises its interest rates for the borrower, or offers fewer loans.

LIBOR can also affect Federal rate cuts. Usually investors such as Effi Enterprises enjoy it when the Federal government cuts rates. But when LIBOR rates soar it restricts people from obtaining loans. This means that the average person does not benefit from the discounted rate because fewer loans are being offered. For those with a subprime mortgage it is important to keep an eye on LIBOR rates.

Generally the LIBOR rates do not affect the US Dollar or have little effect. It mostly has an impact on the Euro, Japanese Yen and the British Pound. However, for monies from the US which are being held in foreign banks, it is a relevant issue.