The period in question spans from 2006 through 2009. This was prior to and into the depths of the financial crisis. The lawsuit filed in US Federal Court last week complained that a handful of leading international banks collaborated to keep the LIBOR rate low. This minimised the banks’ payout to clients on financial products linked to LIBOR. An amalgam of FTC Capital and FTC Futures Funds from around Europe filed suit in mid-April in the US. Another major complaint is from Carpenters Pension Fund of West Virginia. They are seeking to stimulate a class action against the banks suspected of LIBOR fraud. If found guilty under US antitrust laws, claims would be set at triple the monetary damages according to reports on Bloomberg Financial.

LIBOR is an acronym for London Interbank Offered Rate. It is the rate that participating banks set for loans within the group. The LIBOR is thought to indicative of the perceived level of financial risk in the broader market, from the perspective of the bank collective. Individually, the internal rate calculations by the banks themselves are complex. Additionally, the methodology in collecting and reporting the data adds another layer wherein can enter distortion. It will be difficult to map successful lawsuits through the maze of data. The larger question is the reliability of the leading global index which serves as the contractual underpinning for interest-rate swaps and adjustable mortgage lending.

The LIBOR system developed in the 1980s in order to provide a reliable gauge for setting and comparing rates in the growing interbank market which evolved in London. In 1984, the British Bankers’ Association (BBA) spearheaded creation of a standard for rates in interest-rate swaps and along with it the interest-settlement rates. A few years elapsed before the BBA Libor was officially launched in 1986.

Only a select number of international banks participate in the interbank system centered in London. Although transactions occur in several currencies, Eurodollars is the LIBOR peg of most significance. With the advent of the Euro, the term can be misinterpreted. A Eurodollar is a US dollar on deposit in a bank outside of the US. As such, it is outside the regulation of the US Federal Reserve. The Interbank lending reference for Euros is known as EURIBOR and is managed by the European Banking Federation from amongst a larger number of banks.

LIBOR is issued daily before noon GMT by the respected Thomson Reuters (TG) group for the BBA. TG polls the banks that best represent the activity in the interbank lending. Twenty banks are included in the survey, three of which are US based. TG gathers data on the rate charged for Eurodollar loans amongst the group for a variety of maturities.

As part of the methodology, the highest and lowest rates are eliminated. The average is based on the remaining ten rates with central tendencies.

This is known as the interquartile mean. This is then reported as the benchmark rate for comparison purposes. Actual rates will vary amongst participants based on relationships, magnitude, and other specifics of the deal.

Whereas LIBOR is a gauge of activity in large institutional banks, it impacts the broader scope of financial institutions and individuals. LIBOR is the basis of interest rate swaps and forwards that are used to invest reserves and balances around the globe. This in turn affects the profitability of those institutions and the clients they serve.

LIBOR is also the basis for interest-only loans used in commercial banking and for interest adjustable mortgages or ARMs in retail banking.

It was the repackaging and resale of ARMs based on faulty underwriting which contributed to the near collapse of the global financial world.

In May 2008, the Wall Street Journal issued a report that banks might have under-reported the LIBOR rate. This would have under-stated the perceived financial risk in the markets. The report noted that a major bank stated it could borrow three-months LIBOR for 87 bps (0.0087 points) lower than the benchmark rate for credit default insurance.

However, such a discrepancy could have been due to the deal parameters and counter-party specifics. In a more recent article in market on March 18, 201, the Wall Street Journal issued another report highlighting the probe by regulators of three named banks with significant activity in LIBOR.

When the initial report was released, the BBA and the Bank for International Settlements issued responses in May 2008 stating that the data does not support the allegations that banks manipulated rates to enhance their profitability. The usual October 2008 issue of the International Monetary Fund (IMF) Global Financial Stability Review stated “…although the integrity of the LIBOR-fixing has been questioned, it appears that LIBOR remains “an accurate measure of a typical creditworthy bank’s marginal cost….”. The recent probes are a method of publically verifying a system that under-pins the vast global financial market.

The probe into LIBOR follows on the heels of an examination by the EU regulators over price-setting in credit default swaps. Herein, it was posited that banks acted to control the flow of data to self-owned data providers, one in the US and one in Europe.

The $583 trillion credit default swap market is the crux of the 2008 financial meltdown. Transparency in data and methodology in pricing these sophisticated financial products is critical in ensuring fair practices and policies.

The recent lawsuits on LIBOR price-setting may be a fishing expedition that could result in opening a can of worms.

Patrice Horner holds an MBA in Finance, a FINRA Series 7 License, and is a Certified Financial Planner (CFP-US). Any opinions expressed in this article are not specific recommendations, nor endorsements of any products. Individuals should consult with their banker, insurance agent, lawyer, accountant, or a financial planner for advice to address their personal situations.