LIBOR is World’s Most Important Number: Probing Allegation of Shenanigans– Conspiracy, Manipulation, Collusion…

LIBOR is currently being used by both Fannie Mae and Freddie Mac as an index on the loans they purchase.

One of the most important barometers of the international cost of money is under investigation for possible manipulation: It’s LIBOR (London Inter-Bank Offered Rate). This is the interest level that stands behind many mortgage rates and unsecured loans, as well as, providing the essential numbers for trillions of dollars of more complex products.

But while LIBOR is an essential part of the financial scene, only a very few people have any idea what it means, fewer could hazard a guess at the rate, and just a handful know that this vital capitalism component is privately owned and not subject to external regulation. According to MindfulMoney; this lack of oversight is now under fire as its users and rate setters stand accused of manipulating the figures for their own profit. The UK watchdog– ‘Financial Services Authority’ has one investigation, the Canadians are looking into seven major banks, and U.S. authorities including the Justice Department are probing a number of big Wall Street firms.

The LIBOR is the world’s most widely used benchmark for short-term interest rates. It’s important because it’s the rate at which the world’s most preferred borrowers are able to borrow money. It’s calculated every business day in 10 currencies and 15 time-zones, ranging from overnight to one year and is based on the level at which banks have been lending to each other. The sterling three-month LIBOR rate influences the level at which lenders set some rates on loans, especially mortgages to consumers and to businesses. It’s the rate at which banks lend to each other; also, a measure of how much they trust each other and a measure of the credit crunch.

The LIBOR is derived from a filtered average of the world’s most creditworthy banks’ inter-bank deposit rates for larger loans with maturities between overnight and one full year. Countries that rely on the LIBOR for reference rate include; U. S., Canada, Switzerland, and the U.K.  Both Fannie Mae and Freddie Mac use LIBOR as an index for loans they purchase.  Considered one of the most important barometers of the international cost of money, LIBOR has historically reflected money market rates more accurately than ‘prime’ and Treasury-based indices. The LIBOR rate can be found daily in The Wall Street Journal ‘Money Rates’ table.

In the article “What’s in a Number?” by Donald MacKenzie writes: The ‘London Inter-bank Offered Rate’ (LIBOR) matters more than any other set of numbers in the world. LIBOR anchors contracts amounting to some $300 trillion, the equivalent of $45,000 for every human being on planet. It’s a critical part of the infrastructure of financial markets, but it doesn’t usually get noticed. The rates on borrowing, amounting to around $10 trillion (e.g., corporate loans, adjustable-rate mortgages, private student loans…) are pegged to LIBOR.

The level of LIBOR determines the monthly payments on around half of the adjustable-rate mortgages in the U.S.: Rates are set as ‘LIBOR plus a fixed margin’, and reset periodically as LIBOR changes. Even in the UK, where explicit pegging of this kind is rare, LIBOR is a big influence on mortgage rates. LIBOR is an even more important factor in the huge market for interest-rate swaps. The swaps market is the biggest financial market, and most depends on LIBOR.

The British Bankers Association’s (BBA) System for calculating the LIBOR involves a fixed procedure and predetermined panels of banks that was set-up in 1985. The BBA System has worked very well, which is why the participants in financial markets are prepared to have $300 trillion indexed to LIBOR. Much of the most vocal criticism of LIBOR has come from the U.S., and has focused on dollar LIBOR– especially three-month dollar LIBOR, which is the rate used more than any other in the swaps market.

In the articleWhy LIBOR Rate is Important to the U.S. Economy” by MoneyRates Team writes: LIBOR is base interest rate paid on deposits between banks in the Eurodollar  market. A Eurodollar is a dollar deposited in a bank in a country where the currency is not the U.S. dollar. The Eurodollar market has been around for over 40 years and is a major component of international financial market. London is the center of the Euromarket in terms of volume. The index is quoted for one month, three months, six months as well as one-year periods. LIBOR rates quoted in the Wall Street Journal are an average of rate quotes from five major banks: Bank of America, Barclays, Bank of Tokyo, Deutsche Bank, and Swiss Bank.

The most common quote for mortgages is 6-month quote. LIBOR’s cost of money is a widely monitored international interest rate indicator. LIBOR is currently being used by both Fannie Mae and Freddie Mac as an index on the loans they purchase. Most adjustable rate mortgages and credit card interest rates are based on LIBOR. As rates reset, the high LIBOR makes the monthly payment also higher, which will cause higher mortgage rates for this type of loan. Also, higher LIBOR rates will reduce liquidity in the economy.

In the article The Basics of LIBOR- London Inter-Bank Offered Rate by Joshua Kennon writes: The global inter-bank market provides means for financial institutions with excess capital to earn higher rates-of-return by its loaning liquid assets to those in need of the funds.  LIBOR is released each day at 11 a.m. London time. It then fluctuates through the day based upon the market’s expectations for economic activity and future direction of interest rates.  LIBOR loans are expressed in Eurodollars; U. S. currency held by foreign entities, such as British, German banks or insurance company.

Eurodollars are often the result of U.S. companies using U.S. dollars to pay internationally-domiciled  corporations for goods, service, and merchandise purchased.  LIBOR is important because it’s used as the base for variable-rate government and corporate loans and derivative-based products such as credit swaps. A spread of a percentage point-or-two above and beyond the established LIBOR rate will result in a corresponding rise or fall in its cost of borrowing.

In the article “LIBOR Probe Morphs Into Criminal Investigation” by Kyle Colona writes:  The U.S. Justice Department investigation into possible shenanigans affecting LIBOR has now reportedly become a criminal probe, according to Reuters. This is a world-wide effort of ‘serious nature’, says Reuters. Investigations are underway in Japan, Canada, and the UK, and the probe includes a host of regulators and law enforcement agencies who are looking under the hood of several major worldwide banks including; Citigroup, HSBC, Royal Bank of Scotland, UBS, and among others.

But thus far, none of these firms or their employees has been criminally charged in the LIBOR probes, so it’s not clear which way the probe will go, or even, if there is a case for wrong doing. As many in the industry know, LIBOR is set daily in London town for 10 major currencies and debt transactions and bond offerings for a range of maturities. The rate is supposed to reflect the rate at which banks lend to one another and is the peg to which, up to $10 trillion in loans; consumers, companies, and $350 trillion in derivatives transactions are linked. 

Manipulation of  LIBOR could have serious consequences for the global markets; and the ripple effect will surely be felt throughout the financial system. Investigators are trying to determine if traders at the banks in question ‘tried to influence’ the direction of LIBOR up or down, where a shift could mean a windfall of tens of millions of dollars if a trader has bet correctly. In the end this matter  goes far beyond just a civil matter, since manipulating LIBOR does not happen on its own or by negligence, if criminal wrong doing is proven, then the consequences are very serious.

Beyond these current shenanigans– the question being asked is: ‘What happened to LIBOR during the credit crisis?’ According to A.W. Berry; when the most recent credit crisis began and the U.S. Federal Reserve was lowering interest rates and making funds more accessible, the LIBOR continued to rise, while still in the credit crisis.  Essentially, this meant British Bankers Association responsible for setting LIBOR rates was either unable to convince banks to lower rates or not fully cognizant of the implications high LIBOR has on financial markets.

The causes of changes in LIBOR have been measured statistically by comparing the rate to other market lending rates.  The LIBOR is an important banking-lending rate tied to a large amount of money worldwide: When credit and lending risk for banks rise then so does LIBOR. However, when these risks become resolved or are less important than the need for commercial growth, the LIBOR declines. During the unresolved concerns of the credit crisis, LIBOR rose dramatically, even as the U.S. Federal Reserve had consistently lowered its lending rates. Because LIBOR is not regulated, there appears to be a lack of ‘Chinese walls’ at many banks between rate-setters and the traders who can profit if they are ‘better informed’ than rivals.

According to ‘The Financial Times’ the most likely way forward is for regulators to start regulating the rates or at least demanding more information on the process… Also, there is a strong likelihood that this will mean the end of the BBA sponsored process: Watchdogs may consider that an organization which lobbies for banks should not be involved in such a delicate rate setting operation. It could also end the Thompson Reuters role in reporting rates and looking at anomalies– or at least it will have to comply with a demand that reports and other investigations are made public…

The rate at which the banks say they are willing to lend to another is a central plank of the world’s financial system.