Sun Post #1: The LIBOR scandal

The average person is completely unaware of what the LIBOR scandal is.

Your basic, ordinary investor spends enough of this time simply trying to understand the basics of investing. When it comes to getting a handle on the myriad of acronyms in the investing world... well forget that.

So it's easy to dismiss the recent scandal involving allegations that Barclays took steps to rig what's known as the LIBOR.

But don't walk away with the mistaken impression that LIBOR isn't important for average people. As millions of people are about to find out, nothing could be further from the truth.

LIBOR stands for "London Interbank Offered Rate" and actually refers to more than 150 different rates. You can find LIBOR figures for a variety of maturities between a single day and a full year in each of 10 different currencies, including the U.S. dollar, the British pound, the euro, and the Japanese yen.

The calculation of LIBOR is simple.

Every day just before 11 a.m. London time, Thomson Reuters, which is the designated calculation agent for the benchmarks, receives information from the LIBOR contributor banks asking them at what rate they'd be able to borrow funds from other banks. It then calculates the appropriate LIBOR by looking at all the rates submitted, tossing out the top quarter and the bottom quarter, and then taking the average of the remaining figures. So if 12 banks submitted figures for a particular rate, the LIBOR would be the average of the middle six after eliminating the top three and bottom three.

LIBOR has a direct impact on many people. Those who have adjustable-rate mortgages often have their rates tied to an appropriate LIBOR benchmark, with mortgage rate resets based on changes in the LIBOR over time. Add in credit cards, car loans, and other credit, and the British Bankers' Association estimates that roughly $10 trillion in loans base their rates on LIBOR.

As much as LIBOR influences ordinary people's lives, the much larger impact comes from the financial markets. LIBOR figures are used for an estimated $350 trillion in notional value of credit-default and interest-rate swaps. For instance, both Annaly Capital and American Capital Agency hedge their extensive borrowings using swaps tied to LIBOR. All told, more than $800 trillion in loans, securities, and notional derivative contracts has links to LIBOR. Those securities include interest-paying investments which pension funds and other institutional investors own, making for an indirect impact on tens of millions of workers and retirees.

This week the former CEO of Barclays said that banks across the world were fixing interest rates in the run-up to the financial crisis.

Professor of economics and law Bill Black summarizes the issue succinctly:

It is the largest rigging of prices in the history of the world by many orders of magnitude.

Indeed. And since the scandal effects an $800 trillion dollar market – 10 times the size of the real world economy - the impact could be profound.

In the youtube clip above, Matt Taibbi explains the significance:

this is the “mega scandal of all mega scandals”, because Libor is the sun at the center of the financial universe”, and manipulating Libor means that “the whole Earth is built on quicksand.

As much as LIBOR influences ordinary people's lives, the much larger impact comes from the financial markets. LIBOR figures are used for an estimated $350 trillion in notional value of credit-default and interest-rate swaps. For instance, both Annaly Capital and American Capital Agency hedge their extensive borrowings using swaps tied to LIBOR.

All told, more than $800 trillion in loans, securities, and notional derivative contracts has links to LIBOR. Those securities include interest-paying investments which pension funds and other institutional investors own, making for an indirect impact on tens of millions of workers and retirees.

Because of the pervasive use of LIBOR, the benchmarks take on huge importance not only in the interest rate market, but throughout the financial world. During the financial crisis four years ago, when LIBOR soared well above the prevailing Fed funds rate set by the Federal Reserve, analysts concluded that the credit markets had come to a screeching halt with banks afraid to lend to each other. Similarly, during flights to safety that push rates on Treasury bills to artificially low levels, LIBOR serves as another gauge that can provide a different perspective on the credit markets.

Credit card holders, students, local governments, small businesses, small investors and virtually everyone else in the entire world has been impacted by the manipulation.

This is the biggest financial scam in the history of the world.

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Email: village_whisperer@live.ca
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