The LIBOR Scandal Comes To Light

Here is a brief explanation of the LIBOR scandal and a run-down of some of its likely implications:

Rigging the survey

LIBOR stands for the London inter-bank offered rate. It is a measure of the interest rate banks in London use to borrow short-term funds, and it is measured by a survey of several banks. The scandal became public when allegations surfaced that Barclays had falsified its survey answers in an attempt to influence the LIBOR rate for its own benefit.
This would all seem very much like inside baseball -- or inside cricket, given the location -- except for the fact that LIBOR is a benchmark interest rate used the world over as the basis for other lending rates. In other words, if Barclays did manipulate its LIBOR responses, it may have affected countless borrowers and lenders.

What does it mean?

The tricky thing about this scandal is that the impact was subtle, indirect and possibly very widespread. All of that makes specific damages hard to pin down, but here are some general outcomes:

  1. Only very large investors will be able to point to damages. By nature, the impact of rigging the LIBOR survey was very small -- fractions of a percent -- but if there was a prevailing direction to it, that direction may have been to lower certain interest rates. Anyone owning lending instruments may have been hurt, but only very large investors are likely to be able to quantify any significant impact.

  3. Some borrowers actually may have benefited. Some adjustable-rate mortgages are based on LIBOR. These borrowers may have benefited from artificially low rates -- but only very slightly.

  5. Liability will be hard to trace. The LIBOR survey is based on responses from several banks, and then the results are used to set interest rates for countless numbers of completely unrelated borrowers and lenders. Tracing a line from a victim to a perpetrator is going to be very difficult.

  7. It will be a field day for lawyers. Liability may be hard to trace in this case, but some lawyers will get rich trying. They'll find no shortage of potential victims willing to participate in a lawsuit, hoping for a windfall. In this financial environment, everybody already feels like a victim. Now they're just looking for someone to blame.

  9. Situations like this raise the cost of banking. Any wrongdoing in the banking system can hurt people on the front end, but ordinary people with savings accounts, checking accounts and mortgages may also pay in the long run as the cost of policing the system ultimately gets passed along to bank customers.
Because there were innocent borrowers and lenders on both sides of the interest rate equation, the immediate impacts were probably something of a wash, and almost imperceptible in most cases. However, everyone who participates in the financial system stands to be hurt by the loss of confidence and cost of regulation that follows when a scandal like this comes to light.