The London Interbank Offered Rate, a number that spent decades as the central force in international finance and was used to set interest rates on everything from mortgages to student loans, is dead after a long battle with regulators. It was 52.
Known as Libor, the benchmark interest rate once underpinned more than $300 trillion in financial contracts, but was rolled back after a years-long market-rigging scandal emerged in 2008. It turned out that the bankers had coordinated with each other to manipulate the rate by skewing the number higher or lower for the gain of their banks.
Libor could no longer be used to calculate new trades from December 31 – 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 setting the rate for their benefit.
Randal Quarles, then the Federal Reserve’s vice chairman for oversight, gave scathing praise in October, saying Libor “wasn’t what it said it was.”
“It claimed to be a measure of the cost of bank funding in London money markets, but over time it became more of an arbitrary and sometimes self-serving announcement of what banks simply wanted to charge,” Quarles said.
While regulators and central bankers were relieved by his departure, Libor will be mourned by many bankers who have used it to determine interest rates for all kinds of financial products, from different types of mortgages to bonds. .
“There aren’t many corners of the financial market that Libor hasn’t touched,” said Sonali Theisen, head of electronic fixed income trading and market structure at Bank of America. Even so, she said, getting rid of it was “a necessary surgical removal of a vital organ”.
Libor was born in 1969 to Minos Zombanakis, a Greek banker. The Shah of Iran, Mohammad Reza Pahlavi, wanted an $80 million loan and Zombanakis was willing to give it to him. But the question of the interest rate to charge a sovereign ruler was tricky. So he looked at the rate other well-heeled borrowers – London banks – would pay to borrow from each other.
In its early years, Libor was a rising but still adolescent rate, employed for an ever-increasing number of contracts. In 1986, at the age of 17, success was at the rendezvous: Libor was taken over by the British Bankers Association, a trade group later described by the New York Times as a “club of gentlemen bankers”. .
They have made it the basis of virtually every business they have conducted. The Libor was the interest rate the banks themselves had to pay, so it provided a convenient baseline for the rates they charged customers who wanted to borrow money to buy a house or issue a security for finance the expansion of their business.
The Libor has become a figure inscribed in almost all calculations involving financial products, from the most modest to the most exotic. UK banks have used it to set loan rates across the industry, whether denominated in dollars, pounds, euros or Japanese yen. Never before had there been such a benchmark and the daily movements of Libor were the very heart of international finance.
But as Libor approached middle age, troubling health issues began to emerge.
In 2008, regulators in the United States and Britain began receiving reports that banks’ rate reports were wrong. Because Libor relied on self-reported estimates, it was possible for a bank to offer an artificially high or low rate, thereby making certain financial holdings more profitable.
Soon, the media questioned the integrity of Libor, and investigators eventually uncovered a blatant fault in the rate-setting process. In an 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, saying, “Dude, I owe you a lot! Come one day after work and I open a bottle of Bollinger” — a reference to the Champagne producer.
The scandal made international headlines, from the Financial Times to the Wall Street Journal to The Times. Before long, Libor was the butt of jokes on “The Daily Show.”
Global regulators have called for an end to Libor, saying it is potentially inaccurate and vulnerable to manipulation. Andrew Bailey, then CEO of a major UK banking regulator, the Financial Conduct Authority, sounded the death knell in 2017, when he said it was time to “start seriously planning the transition to alternative benchmark rates”. .
The banking industry – which for decades has built trading systems around Libor – has stuck with it, despite the grim prognosis. Many bankers dragged their feet in making the necessary changes because Libor was so widely used in the financial system, prompting exasperated rhetoric from officials tasked with scrapping the rate altogether.
“Holication deniers and stragglers indulge in wishful thinking,” Quarles said in June. “The Libor is over.”
Not exactly, however. Libor was still viable until the end of the year, and some bankers continued to use it to make leveraged loan deals until its dying days. These and other existing contracts mean that Libor will exist in a sort of zombie state until they too come to an end.
Quarles, perhaps reluctant to speak ill of the dead, said Tuesday that Libor’s problems were not necessarily insurmountable.
“You hit the people who did the manipulation and say, ‘Don’t do that again,’ and then you move on,” he said. “You don’t need to rebuild the freeway if people are speeding up.”
Even so, he said, the days of Libor had passed, “and fortunately the market has moved on”.
He is survived by several successors, each claiming his crown.
The Overnight Guaranteed Funding Rate – a rate produced by the Federal Reserve Bank of New York that is based on transaction data, not estimates – has already been adopted by many U.S. banks and is endorsed by the Fed. Others, like the American Interbank Offered Rate and the Bloomberg Short-Term Bank Yield Index, have their adherents. In Britain, the Sterling Overnight Index Average is looking to inherit Libor’s place as the all-purpose benchmark.
J. Christopher Giancarlo, a member of the board of directors of the American Financial Exchange, which calculates the US interbank offered rate, said the Libor was once a “giant”. It was, he said, the foundation of a system that gave everyone in the financial hierarchy a way to take a stake.
“The problem with Mr. Libor is that for a while he had it all,” said Giancarlo, former chairman of the US Commodity Futures Trading Commission. Libor was once “on top of the world”, he said, but became a “disreputable, shaky old geezer in the end”.