The London Interbank Offered Rate (LIBOR) is the interest rate at which large financial institutions, mostly banks, can borrow from one another. The forecast for LIBOR is clear, but the consequences of market manipulation remain uncertain.
LIBOR Rate Forecast
LIBOR is the underlying benchmark for consumer and corporate debt—like mortgages and corporate bonds. Loans are unsecured while maturities range from overnight, to three months, to one year.
LIBOR in U.S. dollars for three-month and one-year maturities currently stand at 0.28% and 0.72%, respectively. Similar to most interest rate benchmarks around the world, it is at an all-time low. As the Federal Reserve of the U.S. begins to raise its own benchmark rate, the federal funds rate, LIBOR, will follow with the upward move.
Chart Courtesy of www.StockCharts.com
The three-month LIBOR rate has moved 20% higher from its 52-week low of 0.23% to the most recent quote of 0.28%. The LIBOR forecast is for a return to normal. (Source: WSJ, last accessed May 15, 2015.)
For example, the three-month LIBOR averaged 2.23% over the last 15 years. It hit highs of 6.85% in June of 2000, and a low of 0.22% in May of 2014. (Source: Federal Reserve Bank St. Louis, last accessed May 15, 2015.)
Despite the efforts of central banks around the world, interest rates must rise from the currently distorted levels. LIBOR is forecast to increase. Other benchmarks reliant on it, such as mortgages, credit card debt, and corporate bonds, will follow suit with the rising move.
The consequences of a higher LIBOR rate are clear: greater borrowing costs for retail and institutional creditors. But the outlook for financial markets globally, as a result of LIBOR’s manipulation, remains less clear.
LIBOR was previously managed by the British Bankers Association. It was set up in the 1980s so that banks could have a reliable benchmark for setting short-term rates. LIBOR is not only used to set interest rates for loans, but it is also an important input for financial derivatives.
The derivatives market ranges from simple agreements to swap-variable interest payments for fixed to complex mortgage-backed securities—the culprits in the financial crisis of 2008. The market value of all derivatives stands at $20.88 trillion, or 1.25 times the size of the entire U.S. economy. (Source: Bank of International Settlements, last accessed May 15, 2015.)
At the risk of understating its importance, LIBOR is a vital benchmark for financial instruments worldwide. Without surprise, it’s been manipulated by financial industry participants—the biggest players in the game.
In 2012, Barclays PLC (LSE/BARC.L) was allegedly purposely understating LIBOR rates to attract clients. On top of that, traders at the bank constantly negotiated for a favorable LIBOR amount. This helped Barclays and other major banks benefit from the resulting outcomes in the derivatives market. Barclays agreed to pay $452 million to settle the allegations. (Source: Business Insider, July 10, 2015.)
Fast forward to 2015 and Barclays is likely to be fined again for violating the previous settlement. This is on top of another set of allegations that Barclays and other banks like UBS Group AG (NYSE/UBS) are facing for manipulating the currency markets.
Another major concern is that other financial markets are being distorted. Notably, the U.S. Department of Justice is investigating financial institutions like The Goldman Sachs Group, Inc. (NYSE/GS) and JPMorgan Chase & Co. (NYSE/JPM) for the alleged rigging of precious metals markets.
As recently as last year, prices for precious metals were set using an elementary routine. Banks would allegedly communicate amongst each other via phone twice a day and set an agreed-upon price. The banks involved were Barclays, HSBC, the Bank of Nova Scotia, and Societe Generale.
Approximately 25 lawsuits have been filed against all the banks involved in the alleged gold fix. Plaintiffs are claiming that trillions of futures contracts related to gold prices were manipulated. (Source: WSJ, last accessed February 23, 2015.)
The countless market manipulation scandals illustrate that buyers should beware and invest in products they thoroughly understand. While it may have not protected retail investors in this case, keeping it simple can steer buyers clear of complex financial products.