LIBOR Scandal

We global citizens looked up to LIBOR, the London Interbank Offered Rate, for so long. LIBOR is the short-term interest rate that global banks use to lend each other money, which has rippling effects into consumer markets and the general economy. We looked up to LIBOR until the dreaded...and perhaps inevitable...LIBOR scandal.

While LIBOR is kind of like the Fed Funds rate in the U.S., there is one very important distinction: the Fed Funds rate is set by the Fed, and LIBOR is not “set,” but rather is based on an aggregate equilibrium...good old supply and demand.

The LIBOR scandal revealed that LIBOR was not so natural after all. What we thought was the market’s natural short-term interest rate was actually “set” like the Fed Funds rate is set, but rather than being set by a governmental agency, it was set by the big banks themselves. Global banks reported their interest rates falsely...either higher or lower than what was the truth. By deflating and inflating interest rates, banks were making money off trades, and making themselves look much more stable and trustworthy financially than they really were.

The LIBOR scandal happened in 2012, which showed that interest rate manipulation probably cost U.S. governments (fed and local) around $6 billion. LIBOR manipulation helped fuel the 2008 financial crisis, since LIBOR is used globally, including in the U.S. subprime mortgage market. It’s safe to say the LIBOR scandal led to more regulations worldwide in the finance market. The LIBOR rate itself was rehoused to try to get it out of the fraudsters’ hands. Time will tell if it works.