Part 1 of a two-part article from the March/April 2021 issue of Dollars & Sense. We will post Part 2 later this week.
By John Summa
Economics textbooks teach you that the London Interbank Offered Rate (known by the acronym “Libor”) is the rate at which big global banks make uncollateralized loans to each other. (An uncollateralized loan is backed solely by the perceived credit-worthiness of the borrower.) For years, Libor was considered a fair and efficient market rate of interest, reflecting money market supply and demand conditions, which gave it legitimacy as a benchmark. It is referenced by a wide range of financial products, including mortgages, student loans, and consumer loans, as well as structured financial products such as mortgage-backed securities and collateralized debt obligations (CDOs). However, in the wake of revelations that surfaced beginning in 2012 that became known as the “Libor rigging scandal,” the world learned that banks were unfairly setting the Libor benchmark at levels that were more profitable for them.
The manipulation of a benchmark interest rate is so abstract that, even if we recognize it as fraudulent behavior, it is hard for members of the general public to understand who was victimized and how much harm was done to them. Was it just the playboys of high finance picking each other’s pockets, or the pockets of their well-to-do clients? Or were they teaming up to pick ours, meaning the bank accounts of average working people? While none of these scenarios are mutually exclusive, my research reveals another dimension of the scandal—that banks may also have been stiffing homeowners by charging inflated Libor rates on their adjustable-rate mortgage loans.
The United Kingdom’s Serious Fraud Office (SFO, analogous to the United States’ Federal Bureau of Investigation), spent seven years looking into suspicions that a number of big banks were colluding to manipulate Libor for their own benefit. The investigation, which ended in November 2019, led to some mid-level traders who were employed by the banks being sent to jail. But it was disappointing to many observers of the scandal that the SFO did not take any further action with the case. When the investigation closed, we lost the opportunity to learn more about exactly what was afoot and how it was done.
One important underreported dimension to the Libor story, which never became part of the SFO’s investigation, is the link between Libor and adjustable-rate mortgage (ARM) loans, many recklessly made to often vulnerable and exploited borrowers in the U.S. mortgage market. The evidence that I amassed as an economic consultant to a Vermont-based independent litigator attempting to bring a class action lawsuit against Bank of America and Wells Fargo was damning enough to cause the banks’ lawyers to agree to discuss a potential settlement offer. Due to technical issues with the class action lawsuit, the case did not move forward. So the data and statistical results never ended up being fully presented in court. However, the Libor research suggests that manipulations designed to raise rates on adjustable-rate mortgages may have unfairly transferred billions of dollars from mortgage borrowers to banks, as well to other related parties involved in facilitating such transactions.
