The LIBOR Problem

People who don’t follow the capital markets on a continuing basis might be forgiven for thinking that LIBOR was the name of a fitness instructor from Norway. But no, it’s actually what a lot of people in the business world, including those of us in real estate, look to benchmark the interest rates that we pay for loans. LIBOR, or the London InterBank Offered Rate, is the rate that 18 international banks charge to lend each other money. It affects consumer debt, corporate debt and about $10 trillion in mortgage loans.  When you’re structuring a loan, for example, the originator may assign a rate of 2% over LIBOR. So, when the news broke that a group of banks was under investigation for rigging the rate, it sent shockwaves across both sides of the Atlantic and much of the financial world. On Monday, Chief Executive Officer Robert Diamond and Chief Operating Officer Jerry Del Missier, both of Barclays, Britain’s second-largest bank,  resigned over the scandal. Barclays agreed to pay a $450 million fine. In testimony to Parliament last week, Diamond apologized and said 14 Barclays traders were involved.

The scandal implies that thousands of loans may have been made on the basis of rates that we artificially inflated. One fear is that it may deepen the housing crisis. The rate-fixing scandal may have caused people to lose their homes to foreclosure, according to London’s Daily News. Moreover, many people have mortgages linked to LIBOR and fluctuations in its rate can affect the size of their monthly home loan repayments. The U.K. Serious Fraud Office joins the U.S. Department of Justice in criminally investigating how derivatives traders and rate submitters colluded to rig interbank offered rates. The U.K. Financial Services Authority is seeking civil penalties against banks.

The reaction stateside has been mixed: While condemning the malfeasance of some traders, Forbes says the scandal shouldn’t be quite the cause celebre it’s become.  “The allegation is that the traders within the bank would try and get those who reported rates to the BBA, and thus influenced Libor, to report false rates so that their trading books would benefit. This is clearly wrong, unethical, immoral and we’ll find out soon enough whether it is in fact criminal. What it isn’t though is a huge thing for the wider economy. Firstly, such manipulations would have been up or down depending upon where the specific book was on any one day: it did not lead to continual over or under statement of Libor. Secondly, the amounts by which it was moved, if it ever was, were pretty small, one of two basis points at most is the generally accepted number.”

Maybe the biggest question going forward is whether LIBOR will survive or whether a global benchmark built on manipulable opinions might be replaced by one based on actual reported trades.

Stay tuned.