The Libor scandal is a complex and messy situation involving interest rates in the United Kingdom, and some critics of the banks say it cuts at the jugular vein of capitalism. Investment banking giant Barclays has already paid a $450 million penalty for its role, and the firm's headman Bob Diamond resigned shortly thereafter.
Just what is the London Interbank Lending Rate, or Libor? "Libor pretty much underpins trillions of dollars of financial products, ranging from derivatives to individual mortgages," explains Mark Scott, a reporter for The New York Times who has been covering the scandal for their DealBook Blog. "The idea was that up to 18 banks get together on a daily basis and submit to the British Bankers Association here in London what they think it would cost them on a daily basis to borrow money from other banks."
The BBA then cuts off the highest and lowest figures, then takes an average of the remaining rates. This resultant rate is then used by financial institutions the world over, and plays a definite role in the setting of interest rates on everything from currency trading to mortgage rates.
"A bank, for example, would use Libor or another financial benchmark to help set interest rates on many of the loans they make. For an adjustable mortgage, for example, a bank might charge them Libor plus an additional amount of interest. It definitely affects people on Main Street."
Regulators allege that investment banks began to manipulate their submissions to the central Libor rate in the wake of the collapse of Lehman Brothers in 2008. In the subsequent financial crisis, banks were waiting for the next institution to collapse, and did not know who to trust. "Regulators are now investigating banks [on the grounds that] they potentially put in a lower rate to underpin Libor, so it would make them look stronger," Scott says.
Authorities worldwide, including the U.S. Justice Department, have been quick to pursue action against the traders who allegedly reported false lending rates to manipulate Libor. Peter J. Henning of The New York Times writes, "The Libor case gives federal prosecutors a chance to go after executives who countenanced misconduct that resulted in abuse of one of the most important financial benchmarks in the world."
Scott believes that these investigations will eventually fuel some genuine change in the system, including a push from within the British government to turn the daily responsibility for setting Libor over to a third party. Despite the widespread outrage among regulators, the reporter believes that the allegations have to be put in context. "Within Barclays itself, the [number of] traders who were involved [is] about 14. It's a very smaller number, but it does get under people's skin [concerning] the culture within investment banking," Scott says.
"Frankly, it is not the first scandal we've seen in relation to investment banks both in the U.S. and in Britain and elsewhere during the financial crisis."