The London interbank rate, a number that spent decades as a central force in international finance and used to set interest rates on everything from mortgages to student loans, has died after a long battle with regulators. was 52.
The benchmark interest rate, known as Libor, had underpinned more than $300 trillion in financial contracts, but was pulled back years after the market-rigging scandal that emerged in 2008. It turned out that the bankers were coordinating with each other to manipulate the rate by distorting the number higher. Or less for the sake of their banks.
Libor can no longer be used to calculate new trades as of 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 the Royal Bank of Scotland, eventually paid more than $9 billion in rate-setting fines for their own profits.
Randall Quarles, then the Fed’s vice chair for oversight, gave a eulogy early in October, saying Libor “was not what it was claimed to be.”
“It claimed to be a measure of the cost of bank financing in London’s money markets, but over time it became an arbitrary and sometimes self-interested declaration of what banks simply wished to collect,” Quarles said.
While regulators and central bankers were relieved by his departure, many bankers will mourn Libor, who used it to set interest rates for all kinds of financial products, from different types of mortgages to bonds.
“There are not many aspects of the financial market that are untouched by LIBOR,” said Sonali Thiessen, head of e-commerce and market structuring at Bank of America. However, she said, getting rid of it was “a necessary surgical removal of a vital organ.”
Libor was born in 1969 to Greek banker Minos Zumpanakis. The Shah of Iran, Mohammad Reza Pahlavi, wanted a loan of $80 million, and Zompanakis was willing to offer it. But the question of the interest rate to sue a sovereign ruler was difficult. So he looked at the price that other wealthy borrowers – London banks – would pay to borrow from each other.
In his early years, Libor was growing but still in his teens, being employed for an increasing number of decades. In 1986, when he was 17, he had a hit: Libor was taken over by the British Bankers’ Association, a business group later described by the New York Times as a “club of gentleman bankers.”
They made it an actual basis for all the work they did. Libor was the interest rate that banks would have to pay themselves, so it provided a convenient baseline for the rates they charged customers who wanted to borrow cash to buy a home or issue a guarantee to fund business expansion.
LIBOR has become a punched number in almost any calculation involving financial products, from the humble to the exotic. British banks used it to set loan rates across the industry, whether they were denominated in dollars, sterling, euros or Japanese yen. There was no such standard before, and LIBOR’s daily moves were the beating heart of international finance. But as Libor approaches middle age, troubling health problems begin to emerge.
By 2008, regulators in the United States and Britain began receiving information that bank rate reports were wrong. Because Libor relied on self-reported estimates, the bank could have offered an artificially high or low rate, making certain financial holdings more profitable.
Media reports soon cast doubt on Libor’s integrity, and investigators eventually uncovered blatant misconduct in the pricing process. In one email from regulators in 2012 as part of an investigation into Barclays, a dealer thanked a banker at another company for setting a lower price by saying, “Dude, I owe you big time! Come in a day at work and I’ll open a Bollinger bottle”— In reference to the champagne product.
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 the end of LIBOR, saying it is potentially inaccurate and vulnerable to manipulation. Andrew Bailey, then chief executive of one of Britain’s major banking regulators, the Financial Conduct Authority, sounded the death knell in 2017, when he said it was time “to start seriously planning the transition to alternative reference rates”.
The banking industry — which has built trading systems around LIBOR for decades — has held on, despite bleak speculation. Many bankers were slow to make the necessary changes because LIBOR was widely used in the financial system, prompting angry rhetoric from officials tasked with taking the entire rate out of commission.
“Deniers and laggards engage in magical thinking,” Quarles said in June. “Libor is over.”
But not exactly. Libor was still viable through the end of the year, and some bankers continued to use it to make leveraged loan deals in their last hours. These and other current contracts mean that Libor will remain in a zombie-like state until it ends as well.
Quarles, which may have been reluctant to speak ill of the dead, said Tuesday that Libor’s problems were not necessarily intractable.
He said, “You hit the guys who rigged up, you say, ‘Don’t do it again,’ and then you move on. You don’t need to rebuild the Interstate if people are speeding up.”
However, LIBOR’s time is over, he said, “and fortunately the market has moved.”
It has been survived by several caliphs, each one claiming his crown.