AMERICANS who save for the future, use credit cards or borrow money for tuition, cars and homes deserve assurance that the interest rates on theirare set in a reliable and honest way.
That’s why the revelation that the British bank Barclays attempted to manipulate the London interbank offered rate, or Libor — one of the benchmark rates used to determine the cost of borrowing around the world — is so disturbing. But the Barclays case isn’t only about misconduct by large financial institutions. It also raises questions about the reliability and accuracy of these key interest rates, which are largely determined by the private sector, without significant government oversight.
When you save money in a money market fund or short-term bond fund, or take out a mortgage or a small-business loan, the rate you receive or pay is often based, directly or indirectly, on Libor. It’s the reference rate for nearly half of adjustable-rate mortgages in the United States; for about 70 percent of the American futures market; and for a majority of the American swaps market, where businesses hedge risks from changes in interest rates.
Libor is supposed to be the average rate at which the largest banks honestly believe they can borrow from one another unsecured (that is, without posting collateral). Libor was set up in the 1980s when banks regularly made loans to other banks on that basis.
However, the number of banks willing to lend to one another on such terms has been sharply reduced because of economic turmoil, including the 2008 global financial crisis, the European debt crisis that began in 2010, and the downgrading of large banks’ credit ratings this year.
Banks have shifted toward secured borrowing and, on occasion, borrowing from central banks like the Federal Reserve and the European Central Bank. As Mervyn King, the governor of the Bank of England, said of Libor in 2008: “It is, in many ways, the rate at which banks do not lend to each other.”
These changes in the markets raise questions about the integrity of this important benchmark.
Read the rest at The New York Times.