STOCK MARKET WATCH -- Wednesday, 7 March 2012

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42. Markets Deserve a Borrowing Rate Banks Can’t Manipulate: View

http://www.bloomberg.com/news/2012-03-07/markets-deserve-a-borrowing-rate-that-libor-banks-can-t-manipulate-view.html

The value of about $360 trillion in financial contracts, ranging from derivatives to adjustable-rate mortgages, depends largely on a benchmark -- known as the London interbank offered rate -- that is demonstrably broken.

Regulators and global banks are trying to figure out how to fix it. They should be looking for a replacement instead.

Perhaps no financial indicator is more important for global finance, and less understood by the people it affects, than Libor. Every weekday morning London time, a panel of the world’s largest banks reports how much it would cost to borrow from other banks in various currencies and time periods, ranging from overnight to a year. An adjusted average of those rates -- the three-month and six-month dollar loan rates are the most widely used -- determines the size of payments on corporate and mortgage loan worldwide. In times of crisis, Libor also serves as an indicator of stress in the banking system: The more that banks are paying for short-term loans, the more trouble they’re in.

Problem is, banks have powerful incentives to fib about their borrowing costs -- a flaw that has become the focal point of numerous civil lawsuits, a criminal investigation by the U.S. Justice Department and a multinational regulatory inquiry into possible manipulation of Libor. Troubled banks can make themselves appear healthier by artificially lowering their reported borrowing rates, which are made public. Manipulating Libor can also help banks that are major players in derivatives markets. Hundreds of millions of dollars can be made on differences of as little as a quarter of a percentage point.