Would you prefer your mortgage rate to be determined by thousands of independent data points or the whims of the global banking elite?
The question is laughably obsolete in a post-GFC world, yet for decades high-street interest rates have been set by an opaque process involving the heads of the world’s largest financial institutions.
Called LIBOR, or the London Interbank Offered Rate, an international panel of bankers has convened every weekday since 1986 to set the rate at which they borrow money from each other.
In turn, LIBOR has been one of the leading benchmarks for banks to determine their customers’ borrowing costs.
That is until this Friday, when LIBOR will be printed for the last time after 37, often scandal-ridden, years.
LIBOR’s retirement is largely ceremonial – most banks stopped using LIBOR to set borrowing costs years ago.
Other benchmarks have appeared in LIBOR’s place.
Since 2017, the New York Federal Reserve has published the Secured Overnight Financing Rate (SOFR), while the Bank of England has administered the Sterling Overnight Index Average (SONIA) since 2018.
SONIA and SOFR have their own unique traits, but they share a crucial difference between themselves and LIBOR: they are determined by thousands of points of real market data, while LIBOR is/was determined by a handful of elite banking bosses.
If that makes LIBOR sound dodgy and prone to manipulation, that’s because it was.
What brought down LIBOR?
In 2012, Bob Diamond resigned as chief executive at Barclays following a scandal that would cost the British banking giant £290mln in damages.
A series of investigations determined that Barclays had been rigging LIBOR from as early as 2005 for its own financial gain.
Investigations and US$9bn worth of fines were subsequently levied against other major banks involved in the scandal, including Deutsche Bank, UBS, Rabobank, and the Royal Bank of Scotland.
Some saw Diamond as a fall guy for what was the structural manipulation LIBOR among the banking elite.
Regardless, the rate-rigging scandal exposed the flaws at the heart of LIBOR and precipitated its eventual downfall.
The rigging worked like this:
- Each day the banks would tell the British Bankers’ Association (BBA) the rate at which they can borrow money from another bank
- The BBA would compile this data, find the average and publish the LIBOR
- But Barclays would submit artificially low rates to give the impression that it could borrow money more cheaply than it actually could
- This made Barclays appear financially healthier than it was
But why do this?
The New York Times reported at the time that traders in swaps frequently asked colleagues to manipulate the figures to benefit the traders, rather than reflecting the actual borrowing costs for the bank.
Additionally, there were instances where certain traders at Barclays collaborated with other banks to manipulate their rates.
LIBOR manipulation allegedly occurred in both upward and downward directions, solely based on the positions held by traders.
The Financial Services Authority (later renamed the Financial Conduct Authority) discovered that requests made to Barclays' submitters were predominantly verbal, and a substantial amount of evidence, consisting of emails and instant messages from derivatives traders, supported these requests.
The FCA uncovered instances of traders pleading with a submitter to provide a lower LIBOR figure: "I'm like, dude, you're killing us," read one message. In response, the manager replied, "just tell him to... put it low."
"Done... for you big boy," said the submitter, to which a trader replied "I owe you big time... I'm opening a bottle of Bollinger."
It is hoped that the newer SONIA and SOFR rates, which underpin hundreds of trillions of dollars worth of loans, will be less prone to manipulation going forward.