Might be time to start paying attention to the LIBOR scandal

The fiasco over calculating LIBOR is a bit complicated, but it might be time to start paying attention.

The story is manipulation of LIBOR, a key interest-rate benchmark. Barclays Bank is one of the biggest banks in England. During the economic crisis in 2008, Barclays was underreporting their borrowing costs, which in turn artificially pulled down LIBOR.

So what?

This is a big deal because of the way LIBOR is calculated and how it is used.

The Wall Street Journal has a good one sentence description of LIBOR:

Libor, a measure of how much banks have to pay to borrow from each other, is drawn up daily following submissions from a group of 16 giant banks, which report their borrowing costs for loans of different maturities and in different currencies.

LIBOR represents the average of what they big banks are paying when they borrow money.

This blended rate is then used as the benchmark for huge volumes of financial transactions. It is quite common for a loan or other financial instrument to have a variable interest rate based on LIBOR plus some amount. So you look up LIBOR, add the incremental rate, then calculate the interest on your loan.

How many transactions are involved? This article quotes another article that suggests the face value of transactions that could be affected is in the range of $800 trillion.

Why play games with your reported borrowing costs?

As best I can tell, Barclays was underreporting their borrowing costs so that they would look more healthy during the 2008 crisis. If you are consistently the outlier on borrowing costs on the high side, that hints to the world that you are in danger and could be the next bank to fail.

So reduce your reported borrowing costs, you look better, and you have a better chance to survive.

Here are some articles to help you get up to speed on what’s going on:

• Rate Scandal Set to Spread – Wall Street Journal
• How Libor Affects Rates on Loans  – Wall Street Journal
• U.K. Scandal Unleashes a Political Backlash – Wall Street Journal
• Barclays Libor Scandal; More Client Headaches for PWC – re: The Auditors
• Barclays Manipulates Libor While Auditor PwC Snoozes – Francine McKenna, Forbes
• Lie More, as a Business Model – Simon Johnson –

Next post – who suffers?