What is the Libor and why you should care
Revelations that banks lied about Libor interest rates should be more rage inducing than the housing bubble in the U.S. And yet, the story seems to be a blip on everyone's radar because the problem was rooted in London banks. It's time to get Liborated.
Here's why you should care: It's not just about London. The Libor underpins the interest rate on U.S. mortgage rates, credit cards, student loans and financial instruments such as derivatives. It has become clear over the past several weeks that banks had lied about interest rates to make more money. The U.S. Department of Justice is readying criminal indictments, according to this Business Week story.
Here is a useful graphic from The New York Times explaining how the Libor works. Still scratching your head? Here is a three-minute explainer video from MSNBC, without the "lie" or the "bore."
The Libor is the interest rate banks charge to lend to each other in London, that is then used as a global benchmark. Think of it as the Fed's interest rate in the U.S., but one that is set by the banks (their interests are fiduciary, and they are accountable to their shareholders) instead of our government's central banking system (its interest is the U.S. economy, and it is accountable to the public).
The banks in London are supposed to self-report the interest rate they think would have to pay to borrow from other banks, and the average of those reported rates are set as the Libor. It turns out banks were fixing interest rates to swing the Libor in their favor so they could make more money on their financial products. Barclays, a British bank, recently settled for $450 million over accusations of rate fixing.
Who knew this was happening and who did nothing has now thrown light on the inaction of Timothy Geithner, the U.S. Treasury Secretary, when he was head of the Federal Reserve Bank of New York. During the same period when his actions to prevent banks from failing were lionized by the movie "Too Big To Fail," he also became aware that banks were lying but failed to sound the alarm. Here is a Washington Post story about his Congressional testimony Wednesday.
Libor rate-fixing is more sinister than what happened in the U.S. housing bubble that crashed the U.S. economy when it popped. The housing bubble was a mixture of irrational exuberance, greed, sloppiness and banks approving loans for houses that people couldn't afford, then repackaging those loans as financial products that could be sold and traded. Responsibility for the crash was spread across multiple financial institutions.
The Libor is about banks lying. They knew they were lying when they reported their rates to Libor, and it's clear they did it to help themselves. Homeowners here were forced into foreclosure when they couldn't make mortgage payments, which were based on a rigged interest rate. Students are probably still making payments on loans today that were set based on a rigged interest rate. Many of us are probably still carrying around credit-card debt that was built on a rigged interest rate.
It's another example of how the financial system is rigged in favor of Wall Street instead of Main Street. Go ahead, get mad. I already am.
Achenblog by Joel Achenbach
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