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Libor scandal for dummies

This outrage may have affected millions worldwide -- including you.

By MSN Money Partner Jul 23, 2012 2:43PM

This post comes from Stacy Johnson at partner site Money Talks News.

 

Money Talks News on MSN MoneyWhen you see criminals like Bernie Madoff doing a televised perp walk, two thoughts probably come to mind. The first is "What was he thinking?" The next: "I'm sure glad that didn't happen to me."

 

In recent weeks, a scandal has been unfolding that could potentially make the Wall Street Bernie look like Sesame Street Bernie. And yet, despite the trillions of dollars involved, the sheer audacity of the fraud, and the irony of so many leaders clamoring for less bank regulation -- Mitt Romney, along with many in Congress, have called for repeal of the Dodd–Frank Wall Street Reform and Consumer Protection Act -- there hasn't been much in the mainstream media about Libor.

 

Other than the name, the Libor scandal isn't all that complicated. In the video below, I ask a finance professor to explain it in simple language. Check it out, then meet me on the other side for more.

How Libor works

You probably don't think much about where interest rates come from. On everything from credit cards to savings accounts, you're presented with a rate, then you simply decide whether to take it or not. Whether you're borrowing or investing, you logically assume the rates you pay or earn are set by competition.

 

But as you learned in the video above, interest rates on trillions of dollars worth of financial products start with a benchmark called the London Interbank Offered Rate, or Libor.

 

While the label makes it sound complicated, it's just the average interest rate big banks pay to borrow from each other. It's called "London" because it's computed in that city. But that's misleading, because it affects interest rates worldwide on some (but not all) adjustable-rate mortgages, credit cards, and student, car, and other types of loans. In addition to loans, it's also used to set rates for institutional investments -- the kind that mutual funds, pension funds, and government agencies might use to earn interest on short-term investments.

 

What's the problem?

Libor isn't set by supply and demand. It's not set by the market or the government. Instead, it depends on the banks involved (including giants like Citibank, JPMorgan Chase, Bank of America, and Barclays) to accurately report the interest rates they'd have to pay to borrow from each other. The highest and lowest rates are thrown out, the rest are averaged, and Libor is set.

 

So Libor depends on honesty. If banks don't tell the truth, Libor won't be accurate -- nor will the interest rates on trillions of dollars worth of loans and investments.

 

Why would they lie?

Banks would lie about the rates they'd pay to borrow for two reasons.

  • The first is to make themselves seem stronger than they are. As with you and me, if a bank is a good risk, it will pay less interest. So if a bank reports that the rate it pays to borrow from other banks is low, the financial world will think it's strong.
  • The other reason a bank may want to lie about what it costs it to borrow is to make money. Major international banks do more than lend. They also trade stocks, bonds, and all kinds of other investments for the same reason any investor does: to make a profit.

Image: CEO holding cash (© Rubberball/Getty Images)Traders working for banks participating in Libor could simply buy an investment that goes up when rates fall, then lie about their rates in an attempt to lower Libor. In short, they could manipulate the market and position their investments to make money, essentially trading on inside information. This is especially true if banks magnified the impact of their reporting by colluding with one another.

 

How does it affect me?

If Libor was manipulated, the results could be far-reaching. Since Libor is the benchmark for many other rates, an inaccurate Libor means millions of people all over the globe might have paid more or less interest than they should have. If rates were artificially low, borrowers for things like adjustable-rate mortgages and student loans would have benefited. But investors like cities, mutual funds, and pension plans may have earned less than they should have.

 

The extent and impact of Libor manipulations is still unknown. The effect on the average consumer is probably small, but as the professor in the video above said, it could be measurable to people with large loans tied to Libor, like those with adjustable-rate mortgages.

What's happened so far?

In late June, Barclays agreed to pay $450 million to settle accusations it had lied in an attempt to manipulate Libor. Other banks participating in Libor are now under investigation, with many experts predicting more banks will be writing similar checks in the days ahead.

 

What should I do?

First and foremost, be mad.

 

Be mad that you're expected to play by the rules in a system where the biggest players don't. Be mad at regulators who didn't properly regulate. Be mad that making billions in profits isn't enough for some financial institutions; they have to game the system to make even more. And be suspicious when you hear someone insisting banks are over-regulated.

 

More on Money Talks News and MSN Money:

17Comments
Jul 23, 2012 9:14PM
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Forget the Dodd-Frank Wallstreet Reform! It's a piece of crap with a LOT of loopholes! It was nothing but a facade - something to make them both look good to the Average American, but still let their Wall Street buddies make money.

 

REINSTATE GLASS-STEAGALL!!  That can be done by either a vote by Congress or simply by an Executive order from a president! THAT'S the real reform. We must start pressing our elected officials to address this.

Jul 23, 2012 4:56PM
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From the above article=Mitt Romney, along with many in Congress, have called for repeal of the Dodd Frank Wall street reform and consumer protection act.

The above statement means, that the big banks, have Romney, and most of the repubs in congress in there back pocket.

Jul 23, 2012 9:01PM
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I hope it leads to the arrest of  all of the greedy, corrupt, corporate bankers...And all the lying cheating Corporate Politicians!

Yes you too Romney! You too Obama!

Time to clean House...that means Congress too!

Democrats and Republicans have both been bought and paid for by Corporate Bankers! Why do you think they bailed out the banks with no vote by us citizens? Why do you think they don't want to mention it in the news? They don't want the bankers to expose the government involvement in the scandals! 

Good luck tomorrow Ron Paul! Thanks to your efforts,..Tomorrow is the day they will vote on auditing the FEDERAL RESERVE BANKING CARTEL! ....It's about dang time!

We're gonna need a lot of paddy wagons when the truth about how deep the corruption runs is exposed! Our government has been operating like a legal Mafia for far to long!

To jail with the whole lot of them! Bring back government of the people, by the people, and for the people, once and for all! Rescue our constitution from the fascist who have destroyed our country! They killed small businesses and the middle class, impoverished the poor, and lined their fat wallets with our working man sweat! Not to mention how the took our jobs to foreign countries to set up sweat shops, waged illegal wars for expanding their corporate footprints, killed millions of innocent people, including sacrificing so many of our own sons and daughters lives, lost in those unconstitutional wars!

I hope this will wake you Americans up and make you wave the flag for our people once again! instead of for our crooked warmongering, job stealing, corporate politicians who have fooled you in to believing they give a damn about you or our country!  It's called TREASON! 
Jul 24, 2012 12:32AM
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What would the American legal system look like if an individual only had to pay a small portion of their ill gotten gains in fines?  The problem with corporate crime is that no one has to take responsibility.  Corporations get caught, get fined, and get back to business as usual.  There is no quick fix through regulation or fines, only the willingness of  villagers to light their torches, sharpen their pitch forks and storm the castle.
Jul 24, 2012 12:54AM
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"And be suspicious when you hear someone insisting banks are over-regulated."

 

That statement would lead you to believe that what the criminals did was legal to begin with.  It was not.  It was ILLEGAL.  The regulations were already in place.  The same argument is always trotted out about gun control.  Criminals don't follow laws or regulations.   This applies whether they wear a pair of jeans and a t-shirt, or a three piece suit and tie with matching hankie.

 

Why is it that when someone breaks a law or ignores a regulation, the knee jerk reaction is to say, we need more regulations.  As if those that ignore the first regulations already in place, will somehow be less inclined to ignore yet another set of regulations.

 

Enforce the first set and send some people to jail for a long time and the message will become clear.

Jul 24, 2012 9:54AM
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What good does it do to fine Barclay's $450m if the money just goes to some government agency that flushes it down the drain of $16Trillion in debt?  Why do government agencies get fine money?  That means just less money is available to pay victims.

It seems to me that the government are thieves just like the banks.

Jul 24, 2012 8:14AM
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What the story is missing is that Timothy Geitner KNEW all about this going on prior to the collapse in 2008.  Where is the outrage about this???  Does anyone think this contributed to the collapse in 2008 and now our Treasury Secretary who oversaw the Fed in NY HAD to have known.  Is this going to shoved under the rug just like Fast and Furious with Eric Holder?
Jul 24, 2012 9:43AM
Jul 24, 2012 10:08AM
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In the history of mankind, every society has been ruled by one of three types of governments.  They are either dominated by a religion, a personality cult, or by greed.  Of the three, I vote for greed every time - it's certain and predictable.  You can trace everything back to the money.

Liberals vote for personality cults, because so many people disagree with their basic tenets that they have to hope a Messianic leader can BS people with pie-in-the-sky fantasies so that they will ignore common sense - like "we can spend more than we make."

They are no different than the religious people - liberalism is a belief system, no different than Christianity or Islam, with little basis in reality.

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