Korva is a scroll of the internet’s best ideas.
Banks lied about the borrowing rate
What LIBOR was
The number was the London interbank offer rate, known as LIBOR. Floating-rate mortgages and loans were set in relation to it, so a figure reported by a small group of banks reached ordinary borrowers.
How it was rigged
The Commodity Futures Trading Commission, the agency that oversees derivatives, found people at big banks fraudulently setting that rate. A number of the banks were simply lying about what they could borrow at, and others were colluding with each other. That derivatives market began with contracts on corn and wheat and later spread to oil and interest rates.
Why it matters
Cleaning up that market was one of the things the agency's chair later counted among his proudest enforcement work. Interest rate markets sound like an institutional affair, yet they reach a mortgage, an employer, an auto loan, and a student loan.
How could banks manipulate LIBOR?
LIBOR was calculated from daily submissions by a panel of banks, each estimating what it would have to pay to borrow. The submissions were estimates, not records of actual loans. The highest and lowest were dropped and the rest averaged. Traders at panel banks could ask the people who made submissions to nudge a number in a direction that helped their own derivative positions.
Why was LIBOR replaced?
After the scandal, regulators wanted benchmarks built from real transactions rather than estimates. In the United States the Federal Reserve backed the Secured Overnight Financing Rate, known as SOFR. In 2017 the UK Financial Conduct Authority announced that banks would no longer be required to submit LIBOR figures after 2021. Most US dollar LIBOR settings ended in June 2023.
How did corn futures turn into interest rate markets?
Futures began as contracts for farm goods like corn and wheat, traded on Chicago exchanges. After the Bretton Woods system of fixed exchange rates ended in the early 1970s, interest rates and currencies started to swing, and traders wanted contracts to manage that risk. The Chicago Mercantile Exchange launched currency futures in 1972. The Chicago Board of Trade launched interest rate futures in 1975.
More from Freakonomics Radio Network
