"It may seem like just another obscure banking scandal," says Roland Jones at MSNBC.com, but an ongoing controversy over the Libor interest rate could have enormous significance for the global financial system. The controversy began in June, when British bank Barclays agreed to pay $453 million to regulators in Britain and the U.S. to settle charges that it had manipulated the Libor, a benchmark interest rate that affects some $350 trillion worth of financial transactions. The scandal has since metastasized to implicate major banks and government regulators around the world, and could be one of the most expensive to hit the financial industry since the 2008 financial crisis. Here's what you need to know:
First off: What is Libor exactly?
Libor is an acronym for the London Interbank Offered Rate, a benchmark interest rate that is published daily. The rate is determined by a group of 16 big banks, which all report how much interest they are paying on short-term loans — the average of which is the Libor. Investors around the world use the Libor to calculate the interest rate on myriad forms of debt, from home mortgages and credit cards to municipal bonds and derivatives contracts.
How did Barclays manipulate Libor?
Libor works on a kind of honor code, so the manipulation part is fairly simple: Barclays reported a lower interest rate than it actually was paying. Barclays' alleged motive was to secure cheaper loans and to make itself appear healthier than it actually was. (Some of the rate-rigging occurred in the midst of the 2008 crisis, when less creditworthy banks were falling like dominoes.) And it's widely suspected that other banks also manipulated the Libor, including several in the U.S., such as Bank of America, JPMorgan Chase, and Citigroup.
Were government regulators aware of the rigging?
Yes. According to documents released by the Federal Reserve Bank of New York, a whistleblower at Barclays informed regulators in 2007 that Barclays was not honestly reporting its interest rate. Treasury Secretary Timothy Geithner, then the head of the New York Fed, says he warned British regulators about possible rate-fixing in 2008. It's an open question whether regulators turned a blind eye to the rigging.
Who are the victims of the scandal?
The manipulation of the Libor has likely affected tens of thousands of financial transactions. The city of Baltimore, for example, is suing a group of banks over accusations that the rigged interest rate forced it to pony up hundreds of millions of dollars in insurance-like contracts to hedge its investments — which in turn led the city to lay off firefighters to offset the loss. Massachusetts and California's public pension system, among others, are also considering bringing charges. However, there are many institutions and people who could have benefited from the rigging — a homeowner, for example, could have received a lower interest rate on a mortgage because of the lower Libor rate.
Analysts expect the banks to be hit with waves of lawsuits. The legal costs alone could cause huge losses for banks, not to mention potential penalties and settlements that could dwarf the one handed to Barclays. That could hobble the financial sector as it continues to struggle with a slowdown in the global economy, and that could dry up sources of credit for businesses and consumers. There is also the potential for chaos, with thousands of investors now able to claim that the contracts they signed are null and void.
How are the authorities responding?
The U.S. Justice Department is reportedly considering bringing criminal charges against several U.S. banks. The Senate Banking Committee is also calling regulators to testify on the scandal, with Fed Chairman Ben Bernanke this week saying the main responsibility for regulating the Libor lay with British banking authorities.