“The world’s most important number” or Libor (the London Interbank Offer Rate) is a survey-based measure of bank borrowing costs that is used to index financial contracts around the globe. With the recent maelstrom of news alleging manipulation of Libor and estimations as to potential damages, it might also be reasonable to consider the other side of the equation: Who may have benefited from this situation? (Or, cui bono, as may be asked in a more sinister vein.)
How is Libor Determined and How is It Used?
Libor is calculated by adding the estimates supplied by leading banks on their estimated costs of borrowing from each other, discarding the highest and lowest to leave an average rate, which then becomes the daily “Libor Fix.” The same calculation is made with other currencies from all over the world as well as at a number of durations—ranging from overnight to a year.
Banks and other firms then use the “fix” to establish the rates at which they will do business with each other, which ultimately determines the rates they offer to their customers, helping set the rate of an estimated $360 trillion worth of financial products worldwide, from mortgage rates to car loans. Libor’s use is not restricted to banking or personal finance; it’s also used as a worldwide interest rate benchmark for corporate transactions and lending agreements.
How Would Anyone Benefit from Libor?
Financial institutions may have benefited in two ways:
- It has been alleged that some financial institutions contributing to the index may have provided rates intended to move Libor in a direction that would favor the bank’s own portfolio of investments.
- Additionally, the suggestion has been made that, during the recent financial crisis, some banks acted to artificially reduce Libor in order to maintain confidence in their institutions. (If funds are cheaply available to banks, they can’t be in such bad shape, right?) Other than the bank itself, who would or could have profited by such a scheme?
This second allegation, especially, suggests that Libor rates were at times artificially depressed. If the base rate for my home mortgage or auto loan is kept low (or lowered) then I as the consumer would appear to benefit from the alleged manipulation, if only to a modest degree. But there are lots of potentially impacted consumers and as mentioned above, commercial borrowers as well. As one example: the $72 billion loan given to AIG by the U.S. Federal Reserve back in 2008 was initially set at Libor plus.
According to a Wall Street Journal analysis in 2008, Libor understatement at that time may have translated into “a roughly $45 billion break on interest payments for homeowners, companies and investors over the first four months of this year.”
Neither consumers nor business organizations are going to look to pay back their Libor “windfall,” but in considering whether or not to seek recoveries of potential Libor damages, many institutions are likely to weigh their wins and their losses and weigh their net positions. Not an easy task. But one that may serve to dampen some forms of civil litigation.