Earlier this summer, I prepared myself for the next Bernie Madoff-like scandal to unfold in the financial industry. I’m not a guru who foresees tragedy, but it seems every summer some new scandal or crisis rocks the financial industry.
This was of particular interest to me because I was going to be working on investment banking at a large international bank in New York City. Essentially, the more trouble the financial industry was having, the more difficult my job and the more hours I would work.
So what was this summer’s headline story? London Interbank Offer Rate, or as it’s commonly called, LIBOR. Oddly enough, many people haven’t heard of LIBOR before this. The LIBOR scandal has been considered one of the biggest in history, but it hardly affected my internship at all, and I rarely even heard talk of it.
Maybe LIBOR didn’t make every news outlets’ headlines since it’s not as close to home as Madoff’s Ponzi scheme or the U.S. debt ceiling that rocked the markets last summer. But though LIBOR happened mostly overseas, it should be of concern to all Americans.
LIBOR should be on everyone’s radar. At its most basic level, it can be explained as the rate at which banks would lend money to one another. This rate is an indicator of banks’ stability, and it can impact profits. The lower a bank’s rate is, the more stable they’re considered.
After the 40 included banks report their rates, the highest and lowest are discarded and the rest are averaged. This sets the LIBOR rate for the day.
The bank most commonly associated with this scandal was Barclays, but they weren’t the only ones involved. During the financial crisis, Barclays was reporting much higher rates than other banks, making them appear less stable. So instead of continuing to report correct rates, they started underreporting to make themselves look better. And, unfortunately, other banks followed suit, J.P. Morgan Chase, Citigroup and Bank of America.
These interest rates affected trillions of dollars of financial products, making this a much bigger deal than Madoff was. Some people benefitted from the scandal, while some were hurt. If you took out a mortgage or a student loan when rates were artificially low, then congratulations, you’re paying less interest than you should be. But if you did the same when rates were artificially high, then you’re probably paying more than what’s fair.
As expected, those people who believe they received an unfairly higher rate are filing lawsuits, including the city of Baltimore.
At its heart, the LIBOR system relies on honesty — honesty from banks, which evidently hasn’t been existent of late. The New York Federal Reserve was aware of the scandal as it was brewing and offered a variety of suggestions to change the way LIBOR was set.
This could have happened somewhere other than London, too. In addition to LIBOR, there is HIBOR (Hong Kong Interbank Offered Rate) and SIBOR (Singapore Interbank Offered Rate). With an entire system based on honestly, there are bound to be lies and mistakes, not just in London.
The LIBOR scandal makes it clear that the system needs to be altered. After the financial crisis, a system based on honesty shouldn’t have existed. And more importantly, it should have been widely publicized. While the LIBOR scandal happened in London, the rates affected financial products in the United States, and the scandal involved U.S. banks. Our media sources didn’t seem to cover the issue like they have in the past, even though LIBOR affected a much larger amount of money. While major financial news outlets like CNBC covered the story, every local station wasn’t reporting on the topic. Even if the event takes place overseas, it can still affect Americans, and should be given the same magnitude of coverage had it happened in the U.S.
If it can happen once, it can happen again — and for a system that relies on honesty, it may not be the best policy.
Ashley Griesshammer is the editorial page editor and can be reached at firstname.lastname@example.org.