Manipulating the LIBOR Rate

?Barclays Bank’s admission of manipulating the LIBOR has significant implications because it is used in conjunction with hundreds of millions of dollars of debt worldwide.

New York Attorney General Eric Schneiderman and Connecticut Attorney General, George Jepsen are looking into potential losses in their states following the recent admission by the UK’s Barclays Bank that it had that it manipulated the LIBOR, also known as the London Interbank Offering Rate. The admission of manipulation is significant because the LIBOR rate is considered the benchmark for short-term interest rates across the financial system and raises questions about how state and local government finances have been affected in the U.S. Even a slight change in the LIBOR rate has significant implications because it is used in conjunction with hundreds of millions of dollars of debt offerings worldwide.

A spokesman for the New York Attorney General said, "Working together, the New York and Connecticut Attorneys General have been looking into these issues for over six months, and will continue to follow the facts wherever they lead." This follows the Nassau County (New York) Comptroller’s initial estimate of the county’s losses due to LIBOR rate-tampering at a cost of $13 million in that county alone.

In simpler terms, LIBOR is the average cost of borrowing for banks and is also used to price debt stock. When the major banks submit their borrowing costs, the top and bottom four figures are thrown out, and the overall LIBOR rate is determined from the average of what remains. The biggest problem with this set-up is that the because the banks can self-report their own numbers, it’s possible for them to push the LIBOR up or down as Barclays’ recent admission acknowledged that some of its officials tried to do. The LIBOR is also important because many other kinds of other financial instruments are tied directly to it, like adjustable rate home mortgages, and the derivatives tied to government bonds.

Another area where manipulating the LIBOR rate could have a major financial impact is through interest rate swaps. After a government agency issues debt, it has to repay the bond-holders of that debt the full amount of principal plus the interest that is often set at a floating, or variable rate. Governments have increasingly turned to interest rate swaps and derivatives made with a third party bank in order to minimize their costs of borrowing money. Although the government issuing the debt might agree to pay a fixed rate of interest based on the original principal on the bond, the government entity will collect money back from that bank at a variable interest rate often based on the LIBOR.  This means that if the LIBOR drops, the government will receive less money, and if the LIBOR rises, the government could receive more money. This is all part of attempting to reduce the total amount of interest a government will pay over time to borrow money. Although not every swaps is tied to the LIBOR rate, and there are other benchmarks that can be used, the LIBOR rate is the one used most commonly. This also makes “messing” with the LIBOR rate a huge deal in the worldwide financial system. The good news is that not all swaps are tied to the LIBOR, and although the “lost” dollar numbers are impressive, they don’t actually reflect potential losses. Instead, they are actually only the principal amounts on which interest rate payments may have been incorrectly calculated, making any real losses much smaller than indicated at first.