LIBOR hiccups

By Reuters Staff
May 30, 2008

This is what investigative journalism should be; it’s disappointing that we may be seeing less of it in the future.

Dogged reporting by Carrick Mollenkamp has shown that some high profile banks have been lying about the interest rates they pay other banks to borrow money. This is important because the rates those banks pay are reported daily and used to compute a reference interest rate called LIBOR, the London Interbank Offered Rate. Trillions of dollars of adjustable rate debt–from corporate bonds to home mortgages to financial contracts like swaps–use LIBOR as the reference rate by which they adjust their rates. (LIBOR + 3.5% = Adjustable interest rate) is one way you might see an interest rate quoted. As LIBOR fluctuates, the interest rate adjusts.

Take for instance, an option ARM. ARM, we all know, stands for ADJUSTABLE rate mortgage. And LIBOR is the input that adjusts.

Here’s what the Journal published back in April:

Libor plays a crucial role in the global financial system. Calculated every morning in London from information supplied by banks all over the world, it’s a measure of the average interest rate at which banks make short-term loans to one another….

The interest rates on trillions of dollars in corporate debt, home mortgages and financial contracts reset according to Libor.

In recent months, the financial crisis sparked by subprime-mortgage problems has jolted banks and sent Libor sharply upward….

The concern: Some banks don’t want to report the high rates they’re paying for short-term loans because they don’t want to tip off the market that they’re desperate for cash.

That article sparked a bit of a firestorm in fixed income circles, and LIBOR jumped the following day.

LIBOR April 16th-17th

But the problem hasn’t gone away. The Journal kept at it, comparing default insurance with borrowing rates to determine that banks still aren’t coming clean about the interest rates they’re paying. This means adjustable-rate borrowers continue to benefit at the expense of adjustable rate lenders.

Here’s a nifty analysis the Journal put together using that methodology. You can see which banks appear to be the most mendacious.

After that second story was published Thursday morning, LIBOR jumped again:

Three-month dollar Libor, which is supposed to reflect the rate at which banks lend to one another, rose 0.03 percentage point to 2.68%, its largest increase in more than two weeks.

Carrick is my hero.

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