What Happened to LIBOR?

I would imagine that you have been losing sleep and wondering what the heck ever happened to LIBOR.  No? One of the most important numbers in finance died at age 52. Actually I’m kidding a little bit, but not entirely.

LIBOR stands for the London Interbank Offered Rate as determined by The Bank of England. It became an international benchmark for short term interest rates and a reference point for many types of loans.

Fifty two years after its creation, The London Interbank Offered rate, a number that spent decades as a central measure of international finance and was used in setting interest rates on everything from mortgages to student loans, died after a long battle with regulators. You may have had a floating rate bank loan or mortgage loan with an interest rate that was pegged at a certain percentage over LIBOR. If LIBOR was at 1 percent, for example, and your loan rate was 3 percent over LIBOR, then your rate was 4 percent. As LIBOR went up or down, so did the interest rate on your loan. That seemed fairly straight forward until we started to hear that maybe the LIBOR rate was rigged and not fair after all.

LIBOR once underpinned more than $300 trillion in financial contracts, but was undone after a several year market-rigging scandal came to light in 2008. It turned out that bankers had been coordinating with one another to manipulate the rate by skewing the number higher or lower for their banks’ gain. There was a joke floating around that it should become the “LIE-bore” rate.

LIBOR could no longer be used to calculate new deals as of December 31, 2021⁠—more than six years after a former UBS trader was jailed for his efforts to manipulate it, and others were fired, charged or acquitted. Global banks including Barclays, UBS, and Royal Bank of Scotland ultimately paid more than $9 billion in fines for fixing the rate for their own profit.

The story goes that LIBOR was created in 1969 by Minos Zombanakis, a Greek banker. The Shah of Iran, Mohammed Reza Pahlavi, wanted an $80 million loan, and Mr. Zombanakis was willing to provide it. But the question of the interest rate to charge a sovereign ruler was a tricky one. So he looked to the rate that other wealthy borrowers like London’s banks would pay to borrow from one another.

In its early years, LIBOR was a growing but still adolescent rate used for a steadily increasing number of contracts. In 1986, it hit the big time. LIBOR was taken in by the British Bankers Association when they effectively made it the basis for virtually all the business they conducted. LIBOR was the interest rate that banks themselves had to pay, so it offered a convenient base line for the rates they charged customers who wanted to borrow cash to buy a home or issue a security to finance a business expansion.

But as LIBOR approached middle age, troubling problems began to emerge. By 2008, regulators in the United States and Britain began receiving information that something funny was going on with the rates being set. Because LIBOR relied on self-reported estimates, it was possible for a bank to submit a rate that was artificially high or low, thus making certain financial holdings more profitable.

Soon, news media reports cast doubt on LIBOR’s integrity, and investigators ultimately uncovered blatant misconduct in the rate-setting process. In one email released by regulators in 2012 as part of an investigation into Barclays, a trader thanked a banker at another firm for setting a lower rate by saying: “Dude, I owe you big time! Come over one day after work, and I’m opening a bottle of Bollinger.” The scandal grabbed international headlines, and before long, LIBOR was the subject of many jokes on “The Daily Show.” Global regulators called for LIBOR’s end, saying it was potentially inaccurate and vulnerable to manipulation, and plans began in earnest to transition to alternative reference rates.

The banking industry, which for decades built trading systems around LIBOR, held on to it despite the bad news. Many bankers dragged their feet in making the necessary changes because LIBOR was so was widely used in the financial system. One stated that, “You whack the people that did the manipulation and say, ‘Don’t do that again,’ and then you move on. You don’t need to rebuild the interstate highway if people are speeding.” Even so, LIBOR’s time had passed, and fortunately, the market has moved on. LIBOR is survived by several successors, each making a claim to its crown. The Secured Overnight Financing Rate, or SOFR is a rate produced by the Federal Reserve Bank of New York that is based on transaction data, not estimates, and has already been embraced by many banks in the United States and has the endorsement of the Fed.

So now you know all about LIBOR. If you want to have some fun, next time you are at a crowded social gathering and making small talk with people, try saying something like, “So, what do you think about what happened to LIBOR?” Then watch everyone slowly move away from you. Thanks for reading.