The 'I' Of The LIBOR : The Indicator from Planet Money The LIBOR interest rate was at the center of a huge international scandal back in 2012. Regulators believed it had to replaced. But is that even possible?
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The 'I' Of The LIBOR

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The 'I' Of The LIBOR

The 'I' Of The LIBOR

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Cardiff Garcia.



VANEK SMITH: I have an indicator for you today, which is good because...

GARCIA: That's what we do.

VANEK SMITH: 'Cause it's Monday.

GARCIA: That's what we do.

VANEK SMITH: This indicator is international. It is crucially important. It affects millions of Americans personally. And it is basically a guestimate.

DAVID ENRICH: It's often referred to as the world's most important number. And it's also one of the world's most arbitrary numbers. It's something that was basically pulled out of thin air every day at lunchtime by a group of low-level bankers at some of the world's biggest financial institutions.

VANEK SMITH: And these low-level bankers figured out that they could move this number around and nobody would really notice or even care. And then some higher-level bankers got wind of that. And soon there was an international multibillion-dollar scandal raining down on the global financial system. I am talking, Cardiff, about LIBOR.


VANEK SMITH: LIBOR. This is THE INDICATOR. I'm Stacey Vanek Smith.

GARCIA: And I'm Cardiff Garcia. You may remember LIBOR as a financial instrument that was caught up in this international banking scandal some years ago. And there was just general agreement that LIBOR had to be scrapped. Regulators agreed it should be replaced.

VANEK SMITH: In fact, regulators just tried to roll out something that was supposed to replace LIBOR, and there were some mixed results. And now people are starting to ask if LIBOR even can be replaced. So, Cardiff, buckle your seat belt. Hang onto your hat because we are about to take an unforgettable, edge-of-your-seat journey into the eye of the LIBOR.


GARCIA: (Laughter).

VANEK SMITH: Are you ready?

GARCIA: I'm very excited about this, Stacey.


VANEK SMITH: I'm trying. It's LIBOR. You've got to do...

GARCIA: I know. I know.

VANEK SMITH: You've got to pull all the levers.


VANEK SMITH: OK. So, Cardiff, the LIBOR. It sounds a little bit like a mythical beast, but in fact it is just an acronym for the London Interbank Offered Rate. It is just an interest rate for loans that moves around a little bit every day.

GARCIA: We get all hyped up for an interest rate.

VANEK SMITH: It's true.

GARCIA: That's what we do here.


GARCIA: Yes, it is.


GARCIA: And this interest rate is used to set other interest rates, so double the excitement.

VANEK SMITH: Mind blown.

GARCIA: And those interest rates are on things like mortgages and student loans and leases of car loans for people from Indiana to Texas to the bonny hills of Edinburgh.

ENRICH: I'm in Scotland, actually, on vacation.

GARCIA: That is David Enrich. He's the finance editor at The New York Times and the author of "The Spider Network," a book about the LIBOR scandal. And, yeah, he's on vacation.

VANEK SMITH: I really appreciate you taking time to talk to me.

ENRICH: Yeah, no, just knock yourself out. I'm fine.

VANEK SMITH: Excellent. OK.

ENRICH: I'm just outside drinking whiskey, watching sheep on a hillside. So I'm totally fine.

VANEK SMITH: You're outside drinking whiskey, watching sheep?



GARCIA: Did you feel kind of guilty calling him on vacation?

VANEK SMITH: No. I was mostly just jealous.


GARCIA: Anyways, back to LIBOR.

VANEK SMITH: Back to LIBOR. So LIBOR started life as this sort of insider-y banking number. The I in LIBOR stands for interbank, if you remember, because this is the interest rate banks charge on loans they give each other. This is about 20 of the world's biggest banks, including Bank of America, JPMorgan, HSBC.

GARCIA: So that's why at least at first it was being done by low-level guys in the basement, as David says, because it was, like, just a between-the-banks thing. Often not that much money was being borrowed by Bank of America from JP Morgan on any given day. And it was sort of just between the two of them. Nobody else really cared what that rate was.

ENRICH: And those numbers would then get cobbled together, and the resulting average would be LIBOR.

VANEK SMITH: But then LIBOR started being used to figure out the interest rates for other things. And over time, weird, little, obscure LIBOR started being woven into stuff everybody cared about like mortgages and student loans.

GARCIA: So let's say a bank sells to Janet (ph) in Indiana a home loan with an interest rate that's LIBOR plus two. What that means is that you take six-month LIBOR, which right now is 2 1/2 percent, and you add two percentage points - LIBOR plus two. But you can see now that Janet also has a stake in how LIBOR moves, whether it goes up or down, because that's what her adjustable rate mortgage is tied to. And it's not just these kinds of mortgages. It's also car loans and student loans and big equipment leases.

ENRICH: We're talking billions and billions of dollars. And then you multiply that by a factor of several thousand probably because it's - LIBOR became imbedded in derivatives and other complex financial contracts all over the world. So it really became the linchpin in many ways of the entire financial system. And the problem with that is that no one was paying any attention to how it was calculated. It was a system that was just ripe for abuse.

VANEK SMITH: And it was in fact abused.

ENRICH: Yeah. Banks realized that they could nudge it up or down by small amounts to increase the amount of money they were making largely on derivatives, but also just the amounts of money they were charging in interest to normal customers.

By the mid-2000s, the bank traders became very aggressive and sophisticated about the ways they were manipulating the rate. And, you know, they would lean on the guy, who's generally a very low-level clerk, basically, in the basement of his financial division, and pressure him to move LIBOR up or down that day to suit the traders' financial interests. And they're just brazen about it. There's no attempt to disguise...

VANEK SMITH: Like, what kinds of things would they say?

ENRICH: Move LIBOR up for me today. I've got a million dollars riding on it. Move it down tomorrow. I've got $2 million riding on it. And I'll buy you a real expensive bottle of champagne if you do what I say.


ENRICH: Yeah. No, completely brazen.

GARCIA: Finally, after years of this, the whole system was exposed. This was back in 2012. And banks got into a lot of trouble. For instance, a lot of them ended up paying billions of dollars in fines to regulators and billions more in private settlements. A few people even went to jail.

VANEK SMITH: Because this was a big deal, right? I mean, the interest payments on millions of our mortgages and car loans were going up or down because, you know, Henry (ph) promised George (ph) an especially nice bottle of champagne. That is just not OK. And people were shocked when they found out how unregulated and arbitrary the system was. And there was a general agreement that this definitely had to change. The bank basement cabal has got to go. But that was six years ago, and nobody can quite agree on what should replace LIBOR.

GARCIA: But so far most countries, including the United States, and major institutions are getting serious about something called SOFR, S-O-F-R. That is the Secured Overnight Financing Rate.

VANEK SMITH: Secured because this rate is no longer being set by guys in a basement. This is a rate based on the price of a bunch of overnight loans, loans that use U.S. government debt as security, as collateral. So these are legit loans.

ENRICH: SOFR is not subjective. It's actually based on real transactions in the marketplace. It completely solves the problem of a bank just making it up to suit their own financial interests. They can't do that anymore.

GARCIA: SOFR, though, does have problems of its own. So first, it was rolled out last month by the Federal Reserve Bank of New York. But initially it was miscalculated, and a bit of chaos ensued. But also, David says, we're just going to have to wait to find out whether it's as corruption-proof as regulators hope. It's almost certainly going to be harder to manipulate than, like, buying Henry some Cristal or a bottle of Dom. But this is all very new, and we're just going to have to watch it carefully.

VANEK SMITH: Meanwhile, mortgages are being written today right now that are LIBOR plus 2 percent or plus 3 percent. And, says David, this is another reason that replacing LIBOR so hard.

ENRICH: LIBOR right now is embedded in financial contracts worth approaching $200 trillion.

GARCIA: Two hundred trillion dollars. And, yeah, that is today's indicator - $200 trillion of mortgages and car loans and student loans and complicated financial instruments all still tied to LIBOR.

VANEK SMITH: And this makes sense if you think about it because if my 30-year adjustable rate mortgage has an interest rate of LIBOR plus two, there has to be a LIBOR for at least the next 30 years. And the bank that gave me that loan is probably going to make sure of that.

ENRICH: Barring some sort of miracle, I really don't see any way out of it. I think this thing is too big. It's stuck in way too many contracts. And if LIBOR were just to go away tomorrow, there is - no one knows how you would actually deal with the resulting mess. You - the only thing anyone knows is that the numbers are almost too big to fathom. And so it's just this huge shadow looming over the financial system still.


GARCIA: Today a big U.S. financial group has started a marketplace for buying and selling futures of SOFR. And that is a big deal because it is starting to weave SOFR into financial markets in a meaningful way. So maybe that's the first step to making SOFR the new LIBOR.


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