Sunday, June 1, 2008

Manipulation of LIBOR

BusinessWeek is running a story on possible manipulation of LIBOR (the story was originally broken by the Wall Street Journal). Now, the upshot is:

Because Libor may be lower than it should be, consumers are actually spending less on interest payments than they should be. "It's one of those rare instances where financial institutions might not be quite on the up and up, but it's worked out to the consumer's benefit," says Keith Gumbinger of mortgage researcher HSH Associates. If the BBA discovers that rates were manipulated, loan rates could bounce up the next time they are reset.
A cheat that actually benefits consumers, nice. How widely is LIBOR used? Glad you asked.
It has the biggest reach in the mortgage arena, where, for example, it was used in 2005 and 2006 to set rates on approximately 75% of subprime, adjustable-rate mortgages (ARMs)—about $700 billion worth of the loans, according to Guy Cecala, publisher of Inside Mortgage Finance.
I had no idea how often LIBOR is used in setting variable rates in the U.S. I'd always thought that the prime rate was king. Personally, I wouldn't be comfortable getting a loan based on LIBOR. It would be my luck that prime would take a dive right when LIBOR took off. (Note: This analysis shows the move roughly together, so I realize my fears of this happening are irrational. However, since I live and work in the U.S., I want loans that track U.S. set interest rates, which in theory track the health of the U.S. economy.)

Update: LIBOR didn't drop as quickly as the prime rate did in the latter half of 2007.