The London Interbank Offered Rate, better known as Libor, is a benchmark interest rate that underpins over $350 trillion in financial contracts worldwide. It plays a crucial role in setting interest rates for a wide range of financial products, from mortgages and credit cards to complex derivatives. However, between 2005 and 2009, several major banks colluded to manipulate Libor to their advantage, perpetrating one of the largest and most consequential frauds in financial history.

Introduction to Libor

The Libor is calculated based on submissions from a panel of major banks, who report the rate at which they could borrow funds on an unsecured basis. This allows the Libor to function as a proxy for banks’ credit risk. The British Bankers’ Association (BBA) compiles the submissions and produces Libor rates for five major currencies across seven maturity periods, ranging from overnight to 12 months.

Libor influences interest rates on everything from derivatives and mortgages to student loans and credit cards. It also serves as a benchmark for the costs of funds in financial markets. Many contracts tie payments directly to Libor, so even small movements can transfer billions between counterparties. Ultimately, Libor affects the borrowing costs of consumers, companies, and governments worldwide.

The Scandal Unfolds

In 2012, authorities uncovered evidence that banks had been deliberately manipulating Libor since 2005 to profit from derivatives trades linked to the benchmark. Barclays Bank was the first to settle accusations of rate rigging with regulators in June 2012, paying fines of $453 million. Soon after, it emerged that up to a dozen global banks were involved in the scheme.

Key Players

The Libor manipulation scandal touched many of the biggest names in banking, including:

  • Barclays
  • UBS
  • Rabobank
  • Royal Bank of Scotland
  • Deutsche Bank
  • Société Générale

These banks colluded to nudge Libor up or down to benefit trading positions tied to the rate. Traders at different banks coordinated their Libor submissions through emails, instant messages, and phone calls. The manipulation continued on an almost daily basis for years.

Methods of Rigging

Banks distorted Libor using several techniques:

  • Lowballing – During the financial crisis, banks understated borrowing costs to appear healthier than they were. This pushed Libor lower than its true rate.
  • Highballing – At other times, traders pushed Libor higher to increase profits on derivatives trades.
  • Bashing the close – On key settlement dates, banks manipulated Libor sharply up or down to maximize gains.
  • Leaving false trails – Banks created fake paper trails to cover up their maneuvers. For example, they asked colleagues to submit rates that justified their own rigged figures.

Red Flags Ignored

Warning signs emerged as early as 2007 that Libor was suspiciously stable compared to market fundamentals. In April 2008, The Wall Street Journal published an article questioning whether banks were truthfully reporting borrowing rates.

Still, regulators did not launch investigations until years later. This delay allowed manipulation to continue through 2009. Authorities have faced criticism for failing to act on red flags in Libor.

The Fallout

The Libor scandal had enormous repercussions that are still unfolding today. It eroded trust in banking and sparked lawsuits and investigations worldwide.

In total, manipulation fines and penalties have exceeded $9 billion across several major banks. UBS paid $1.5 billion, Barclays paid $453 million, and Rabobank paid $1 billion. These record fines indicate authorities are taking rate rigging very seriously.

Investigations and Lawsuits

Regulators across North America, Europe, and Asia launched sweeping investigations into Libor manipulation. In the U.K., the Serious Fraud Office pursued criminal charges against individuals.

At the same time, banks faced class action lawsuits from institutional investors, pension funds, hedge funds, and municipalities whose investments lost value due to rigged Libor rates. These cases are ongoing.

Tighter Regulation

In response to the scandal, the U.K. replaced the BBA with the Intercontinental Exchange (ICE) as Libor’s new administrator in 2014. ICE has strengthened oversight and compliance to restore credibility.

Many contracts have moved from Libor to alternative benchmarks not prone to manipulation. Nonetheless, Libor remains deeply embedded in markets, and financial authorities continue working to prevent future manipulation.

Impacts on Financial Products

Libor touches everything from complex swaps to common mortgages. The effects of rate rigging reverberated across global markets, impacting investors, borrowers, and savers alike.

Mortgages

Banks’ understated borrowing costs kept Libor lower than it should have been in 2008-09. This means higher interest payments for many homeowners with adjustable-rate mortgages tied to Libor. Cambridge University economists estimate Libor manipulation cost U.S. mortgage borrowers $9 billion collectively.

Student Loans

Interest rates on federal and private student loans are also linked to Libor. Lowballing likely cost student borrowers billions in excessive interest charges. Approximately $330 billion in student loans originated just from 2007-2009 carry inflated interest due to suppressed Libor.

Municipalities

Cities, towns, and public entities lost big when they purchased Libor-based interest rate swaps from banks. These derivatives were meant to hedge risk on bonds issued for public infrastructure. Instead, rate manipulation caused public entities to pay out more on swaps.

Institutional Investors

Pension funds, mutual funds, insurance firms, and municipalities all hold floating-rate securities tied to Libor. Artificially low Libor rates deprived investors of full returns they were owed. Fannie Mae and Freddie Mac together lost around $3 billion on financial contracts due to rate rigging.

Key Takeaways

The Libor scandal offers important lessons for ethics and governance in banking:

  • Manipulating Libor undermined market integrity and damaged public trust in banking. Restoring credibility remains an ongoing process.
  • Regulators must act quickly on warning signs instead of letting problems fester. This requires resources and coordination between agencies.
  • Audits and oversight must keep pace as markets grow more complex. Tracking benchmarks like Libor still requires vigilance.
  • Banks need stronger internal controls and culture to nip misconduct in the bud. Compensation incentives should reward lawful behavior.

Though challenges remain, the financial system is stronger today thanks to lessons learned from the Libor debacle. Authorities now have deeper insight into detecting and deterring interest rate manipulation that undermines markets.

Conclusion

The Libor scandal starkly revealed fundamental weaknesses in banking culture and regulation. For years, traders pursued profits with no regard for ethics or consequences. Manipulation harmed countless investors, borrowers, and public entities. Billions of dollars in fines reflect the gravity of betraying public trust.

A decade later, the effects persist. Lawsuits and legal actions grind on. Contracts continue migrating to new benchmarks. Nonetheless, Libor remains deeply embedded in global finance. While progress has been made, authorities must remain vigilant to uphold market integrity and prevent such large-scale manipulation from recurring. For the public to maintain confidence in banking, there can be no room for schemes that defraud and abuse the system.