U.S. Borrowers Deserve Protection from Libor

In the wake of the financial crisis caused in large part by the reckless behavior of banks, we have wrestled with institutions that are "too big to fail" and "too big to jail."

Now, after evidence of a widespread fraud on a key benchmark interest rate that has cost borrowers and savers billions of dollars, we may be dealing with something "too big to replace."

The rate in question, which is used to adjust interest rates on everything from swaps to mortgages, is the infamous Libor, an acronym which stands for London interbank offered Rate — the rate at which banks in London supposedly make unsecured loans to each other.

It emerged last year that some of the 18 international banks involved in setting Libor each day were manipulating this rate, which means that on each of millions of securities, loans and retirement plans using Libor as a benchmark someone — U.S. cities and school districts, homeowners, retirees — got cheated.

Regulators found e-mails from bank staffers asking friends at competing banks to fudge the rate in return for steering them brokerage business — or a bottle of champagne or, in one case, leftover sushi!

Three banks — British banks Barclays and RBS and Swiss bank UBS — paid a total of $2.5 billion in fines for falsifying Libor rates.

So once this malfeasance was discovered, banks stopped using the compromised rate in their products, right?

Nope. As with so many of the banks' abusive practices, regulators are moving at glacial speed to rectify the situation, and in the meantime this dubious benchmark continues to be used in numerous financial products.

After due deliberation, U.K. authorities announced they will remove oversight of Libor from the British Bankers Association and put it under government regulatory authorities.

But governance is not the only problem with Libor. The fact is that banks have virtually ceased making unsecured loans to each other so that Libor is pretty much a total fiction.

For this reason, Gary Gensler, chairman of the Commodity Futures Trading Commission, the U.S. agency responsible for regulating swaps, suggested in a speech last month in London that it is time to find a benchmark rate that is more honest in spite of Libor's widespread use.

"It's best that we not fall prey to accepting that Libor or any benchmark is 'too big to replace,' " he told an audience of regulators and bankers.

Last month's annual report from the Financial Stability Oversight Council — the interagency body set up in the U.S. in the wake of the financial crisis to identify and defuse potential threats to the global financial system — listed the damaged integrity of Libor as one of the major potential risks it is currently worried about.

Calling attention to the dearth of any actual transactions at this "interbank" rate, the report warns, "This situation leaves the financial system with benchmarks that are prone to and provide significant incentives for misconduct."

Gensler documented the fictitious nature of Libor for his London audience in a series of slides comparing bank credit rates during the recent crisis over a possible exit by Cyprus from the euro.

While other measures of credit for international banks, such as the cost of credit default swaps for these institutions, were swinging widely during this period, the banks' submissions for Libor remained unchanged.

"One might have thought the two would have had some relation to one another," Gensler said.

What Gensler and the FSOC want is a benchmark set by on observable process anchored in a real market. For instance, while many adjustable-rate mortgages in the U.S. are based on Libor, others use much more widely based or verifiable benchmarks, such as the cost of funds index (COFI) from the San Francisco Federal Reserve or the one-year constant maturity Treasury (CMT) based on an average of yields on Treasury securities.

However, not only are the big banks resisting any change, authorities in the U.K. are dragging their feet on scrapping Libor, arguing that improved governance will help and that a change of this scope would be disruptive.

The U.K. wants at all costs to maintain London's role as a hub of global finance. Financial and related professional services employ some 2 million people in the U.K. and account for nearly 15% of the country's GDP, more than in any other industrial country.

So London is showing little sense of urgency even in making the move to better supervision, let alone finding suitable alternatives.

If borrowers and pensioners here are to be protected from further losses due to fraudulent manipulation of this key rate, it will be up to U.S. authorities to keep pressing for alternatives, even if they have to do it alone.

Source: http://www.usatoday.com/story/money/business/2013/05/14/delamaide-column-libor-scandal/2158085/

How Rigged Are The Markets? Libor, ISDAfix And Now The Oil Price...

It seems that news about the fixing of trillion dollar markets is becoming, well, rather routine. First there was Libor, then there was the announcement that the Commodities Futures Trading Commission (CTFC) was investigating the possible rigging of the interest rate swap rate, another market in the hundreds of trillions. Then in mid-April the EU announced that it was investigating possible price manipulation in the $165 trillion physical-oil market. That's three price fixing scandals slap bang on each other's heels, all involving trillion dollar markets.


The public has not yet got worked up about the first two since the instruments involved are so far out of the ordinary person's view that the response, if you stopped someone on the street would be, "Sorry, never heard of it..." The alleged oil price scandal, however, could strike a lot closer to home. Motorists around the world are already furious over the cost of petrol and diesel at the pumps. While the vast majority of them probably feel that the oil companies are profiteering, the general feeling seems to be "Oh well, thing are as they are..." But if it transpired that instead of just being opportunistic, some of the major oil companies were actually involved in criminal activity things could get ugly.

Being a banker was almost a dangerous career to be in, for a few years after the smash, and bankers are not wholly out of the woods yet. Being an oil company executive could soon attract similar opprobrium if the EU investigation turns up any wrong-doing. A hate campaign against the oil companies, in a world that continues to run on oil and gas despite the strides being made in renewables, would not be a good thing.

The EU began with an investigation into possible price fixing by Royal Dutch Shell, BP and Statoil, three of Europe’s biggest oil exporters. According to Bloomberg EU investigators have now asked Neste Oil, Finland’s only refiner, to provide them with information regarding the potential manipulation of global crude and biofuels markets. Bloomberg also reported that Pannonia Ethanol, a Hungarian bio-fuels producer, has lodged a complaint with the European commission after it was denied the opportunity to contribute to the price setting process carried out by data-price setting company, Platts. There is plenty of speculation that the EU investigation will widen out pretty rapidly once the investigators start going through oil company emails and memos. Neste has said it is not a target of the investigation but will provide information into the investigation. Refineries, as major buyers of crude, are in a good position to know if they have been facing price fixing by supposed competitor suppliers, so their contribution is bound to be at least interesting.

Source: http://seekingalpha.com/article/1449461-how-rigged-are-the-markets-libor-isdafix-and-now-the-oil-price?source=google_news

Investigation Into Oil Industry Price Rigging Mirrors LIBOR Scandal

The European Union is investigating price-rigging in the global oil market, a widely-known yet unaddressed problem. That investigation hit a peak with last Tuesday’s raids of British Petroleum, Royal Dutch Shell, and Statoil offices. By the end of the week, Sen. Ron Wyden (D-OR) asked the U.S. Justice Department to undertake its own investigation into the effects on U.S. consumers.

Day-to-day oil transaction prices are based on benchmarks set by private firms, and the EU investigation focuses on the firm Platts, whose oil price benchmarks are “the most influential,” according to CNN Money. By manipulating individual transations late in a given day, traders can tweak the next day’s benchmark to increase their profits on other deals.

This looks to be very similar to last year’s massive, under-covered LIBOR scandal, in which megabanks colluded to gear a supposedly market-driven interest rate toward their own interests. CNN Money explains the shared pitfalls of basing daily price-setting on voluntarily-provided, unaudited data from the biggest players in the two industries:

“[T]hey are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities,” the review, led by former financial regulator Martin Wheatley, said in August . “To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.” […]

There are also concerns about the fact that reporting to Platts is done by traders voluntarily. In a report issued in October, the International Organization of Securities Commissions — an association of regulators — said the ability “to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data” submitted to Platts and its competitors.

LIBOR manipulation impacts $800 trillion in assets globally. Similarly, oil prices are a core driver of the price of nearly every consumer good, especially food. LIBOR manipulation helped force massive cuts to public services in American cities by blowing up the balance sheets of those cities, and the apparent manipulation of oil prices is likely to have a similarly long and destructive reach.

The shared features of the LIBOR scandal and the burgeoning price-rigging investigation in the oil industry suggest a policy lesson: Left to themselves, the biggest industries in the world tend to cheat in their own interests, at great cost to consumers.

The LIBOR scandal, regarded as the largest financial fraud scandal in history, led to over $2.5 billion in fines and forced changes in the U.K. Under a law passed earlier this year, the process by which LIBOR is set will receive tighter government oversight from a new agency. But that change is insufficient, according to the American head of the Commodities Futures Trading Commission, and fraud remains a possibility.

These structural incentive problems crop up in myriad other markets. Finance expert Barry Ritholtz has a roundup of dozens of other types of market manipulation by insiders, far beyond oil and LIBOR. Privately and voluntarily generated core prices tend to discourage competition at the expense of consumers, as economist Costas Lapavistsas argued earlier this year in the Financial Times. “The answer,” according to Lapavistas, “is public intervention in the rate-setting process, whether through the central bank or otherwise.”

Source: http://thinkprogress.org/economy/2013/05/20/2036101/investigation-into-oil-industry-price-rigging-mirrors-libor-scandal/?mobile=nc

Libor 'Often Completely Made Up'

A top American regulator has suggested that Libor was often "completely made up" and that authorities could not guarantee the rate is free of fraud.


Gary Gensler, chairman of the Commodity Futures Trading Commission, likened Libor to an estate agent trying to sell a house.

"They are trying to reference the price of the houses in the neighbourhood [when] there have been no transactions in the neighbourhood and furthermore, the agent is not willing to share the data and is often just making it all up," he told the BBC.

Banks have already been fined hundreds of millions for attempting to rig the Libor rate, which is a benchmark interest rate used to fix the cost of borrowing on mortgages, loans and derivatives worth more than £28 trillion globally.

Speaking about the scandal, Mr Gensler commenting on "pervasive rigging" and said authorities could not guarantee the rate was free of fraud.

"We have a lot more work to do," he said.

His comments came as the Financial Services Authority - Britain's regulator - said it will publish its internal review into when it first knew about banks rigging the Libor rate within weeks.

The watchdog told parliament's Treasury Select Committee in a written submission that the review was being conducted by its internal audit division.

The FSA was responding to the committee's report last year on the Libor scandal.

Members of the committee were concerned the watchdog was two years behind US regulatory authorities in starting formal probes.

The FSA said in its submission it had worked jointly with the US authorities from 2008 onwards.

Source: http://www.businessinsider.com/libor-often-completely-made-up-2013-2

When Bankers Lie

Although few have ever heard of it, there's probably no number more important to the global financial system than the London Interbank Offered Rate, or LIBOR. Defined precisely, LIBOR is a set of different interest rates that the world's largest banks charge one another for cash loans denominated in US dollars.


Because of its centrality to the economic system, and the trust placed in it, LIBOR is used to calculate everything from consumer loans and home mortgages to exotic financial derivatives and investments. LIBOR makes the financial world go round, influencing the price of everything. Fortune 500 companies decide whether or not to invest billions in new factories and product lines based on LIBOR's direction. Governments rethink their debt levels and spending when LIBOR ticks up and down.

It turns out, however, that LIBOR has been a lie, and that the world's biggest banks rigged the rate to skim off billions of dollars in value from other corporations and the general public. In a devastating set of revelations that began to surface two years ago, the panel of the largest global banks that set the LIBOR rate conspired to manipulate it, to increase or decrease LIBOR, solely because a higher or lower quote on particular days would allow them to reap millions in instant profits.

US authorities working with regulators in the UK, Japan, Switzerland, and Singapore are currently investigating upwards of two dozen banks in what is probably the single biggest financial crime ever perpetrated. So far, employees of Barclay's, UBS, and Credit Suisse have been fired, arrested, and charged. Many more criminal prosecutions are surely coming, but the real battle will be in the civil courts and the court of public opinion.

To date only a handful of civil lawsuits have been filed, the first shot fired by the city of Baltimore early last year. Last month, the County of San Mateo, city of Richmond, and the East Bay Municipal Utility District filed their own cases which were quickly consolidated into a growing class action to be heard in New York's Southern District Federal Court.

Now San Francisco is set to enter the ring. On January 29, Supervisor John Avalos called for public hearings to review the impact of LIBOR manipulation on San Francisco's finances, starting next week. While other cities and public agencies might be ahead in the federal courts, Avalos's recommendation takes the investigation further, and in a different direction.

"We're trying to assess how the LIBOR scandal affects San Francisco, and that's what the hearing is about," Avalos told the Guardian. "These banks rigged the financial markets for their own benefit and the global economy suffered as a result."

While early indications are that San Francisco is better protected than many jurisdictions, Avalos said, "I think it's important to stand with other cities and counties that are suffering." Or as his legislative aide Jeremy Pollock told us, "When a major city like San Francisco calls for hearings, it'll get a lot more attention. The hearing will be an educational process for everyone to understand how this complicated financial world really works."

Former Supervisor Chris Daly, now the political director for Service Employees International Union Local 1021, which represents most city employees, said there's a need to hold the banks publicly accountable. "These other jurisdictions that have filed suit haven't had a big public process. We don't want to see settlements for less in courtrooms. We want to see the full public exposure of the issue, and in terms of the cause of bank accountability, it is the better approach."

Avalos has already met with the heads of different city departments and agencies in an effort to determine what kinds of losses the public might have sustained as a result of LIBOR rigging. Pollock said the city's finance staff and attorneys are currently working closely with the city's airport, retirement system, and Office of the Treasurer to gauge the size of the problem.

"LIBOR rigging may have impacted the payments under the airport's swaps," said Kevin Kone, who oversees capital finance for the San Francisco International Airport. The swaps Kone is referring to include seven interest rate swaps that the airport used to convert variable rate debts into fixed rates for half a billion of SFO's bonds (see "The losing bets," 2/28/12).

The swaps require SFO to pay a fixed rate of between 3.4 and 3.9 percent on its half-billion dollars in debt, while the banks pay about 60 percent of LIBOR. When SFO signed these swap contracts years ago, 60 percent of LIBOR was roughly equal to 3.4 percent, meaning the net payments between SFO and the banks basically canceled one another out. However, if LIBOR was later rigged downward by the banks, then the net interest rate payments would shift in favor of the banks, draining hundreds of thousands or even millions from SFO's capital budget.

"As an example of the order of magnitude, if LIBOR were set artificially low by 0.25 percent for a full two years, the Airport would receive $900,000 less each year (for a total of $1.8 million) than it should from its swap counterparties," explained Kone in an email.

The airport's counterparties on its swaps included JP Morgan Chase, Merrill Lynch, and Goldman Sachs. JPMorgan Chase sits on the committee of banks that sets various LIBOR rates, as does Bank of America, which bought Merrill Lynch in 2008. Both JPMorgan Chase and Bank of America are named as conspirators in the LIBOR lawsuits pending in federal court. JPMorgan Chase and Bank of America are also the subject of federal criminal investigations concerning LIBOR rigging.

Other losses may have been suffered by the San Francisco Employees' Retirement System which makes investments in derivative instruments that are linked to LIBOR. "The retirement board has been looking at this," said Nadia Sesay, director of the Controller's Office of Public Finance. "We know Retirement has exposure and they're assessing their portfolios."

According to the most recent audit of the Retirement System's portfolio, SFERs holds two interest rate swaps on its books with a notional value of $15 million. In prior years, SFERs held other swaps. In 2010, the Retirement System's audit showed three interest rate swaps with a total value of $41 million. Over the last two years these swaps drained $5.3 million from the pension system, and some of these losses might have been due to the downward manipulation of LIBOR. Also on the Retirement System's books are other investments in bank loans, options, and other securities that might have been impacted by the LIBOR fraud.

Still more losses due to LIBOR-linked instruments on the city's books will be investments held by the city treasury in pooled funds. Banks offer various investment products to local governments that need a temporary place to park millions or billions in cash; the returns on these investment are often pegged to LIBOR. Just as with the airport's swaps with JPMorgan and Merrill Lynch subsidiary, often times these so-called "municipal derivatives" investments are sold to cities by the same global banks that sit on the British Banker's Association panels that determine the various LIBOR rates.

That's one of the most alarming things about the LIBOR scandal: how absurdly easy it was for just 16 banks to rig the entire world financial system in their favor for several years on end. LIBOR isn't actually a market rate that is determined by the loans banks make to one another. Rather, it's a rate the banks claim they would able to secure loans from their peers, and the final LIBOR numbers for any given day are determined not by some independent authority, but instead by the British Bankers Association's panel members — the banks themselves.

"The problem is that there's a clear conflict of interest," explained Rosa Abrantes-Metz, an economist at the NYU Stern School of Business who has closely studied LIBOR and is an expert in financial markets and cartels. "Banks make proprietary trades on instruments related to LIBOR, so they do have an interest in moving LIBOR in their own favor."

Abrantes-Metz is currently working as an expert in several LIBOR lawsuits. Among her recent research findings in studies that tracked LIBOR alongside other economic indicators is that all the conditions of a potential conspiracy are present, and empirical evidence points toward coordinated fraud. "The banks had, as we say, the means, motive, and opportunity," concluded Abrantes-Metz.

Regardless of what San Francisco's public hearings on LIBOR uncover, the road ahead will be long and complicated. When asked about the the expected flood of LIBOR litigation, Abrantes-Metz said it's just getting started. "We've only had the settlements of three banks with the authorities [Barclays, UBS, and Credit Suisse]. I've read there are investigations of 14 of the 16 banks that were on the LIBOR panel. That's just US Dollar LIBOR."

"Then there's Euroibor, and there's 40 banks on that panel. Then there's Tibor which some overlapping banks with Yen Libor banks," said Abrantes-Metz, referring to other key global interest rates denominated in Euros and Yen. Like LIBOR, these lesser rates are used to calculate the values and obligations of trillions in securities and payments.

"Those are just the governmental investigations," said Abrantes-Metz. "I'm sure as more evidence comes out of these settlements it will probably generate more private litigation. I think this is to go on for very many years."

Meanwhile, a proposal that Avalos made in the fall of 2011 to have the city start a municipal bank is nearing completion of its legal analysis by the City Attorney's Office. While it's legally complicated and wouldn't eliminate the local need for big banks, he said the LIBOR scandal reinforces the need for alternative lending institutions with great public accountability. "My goal is this year to have something on paper that will lead to a municipal bank," Avalos told us. "These institutions are willing to rig the system, and we could protect ourselves more locally if we had a banking institution."

Source: http://www.sfbg.com/2013/02/14/when-bankers-lie

Gensler: Libor Isn't Useful for Setting Rates

An international financial benchmark used to set interest rates on many mortgages, car loans, futures market trading and other transactions "is unsustainable," a top U.S. market regulator said Thursday.

Known as Libor — an acronym for London Interbank Offered Rate — the financial benchmark represents the rate at which global banks operating in London say they would be able to obtain unsecured loans from each other for periods ranging from a few months to one year.

But the Libor system has come under embarrassing global scrutiny after evidence emerged that financial traders and supervisors regularly rigged the rate, a finding that raises the possibility some mortgage and loan rates could be improperly high or low.

Three banks, England-based Barclays, Swiss giant UBS and Royal Bank of Scotland, collectively have been fined more than $2.5 billion in enforcement actions. Several other banks, including U.S.-based Citigroup, JPMorgan Chase and Bank of America, have said they are cooperating with investigators' requests for Libor-related records.

Besides the growing scandal, Gary Gensler, chairman of the Commodity Futures Trading Commission, told a financial markets conference in New York that the integrity of the Libor system has also been undermined by shifts away from the practice of banks lending unsecured funds to each other.

As a result, "I believe that continuing to reference such rates diminishes market integrity and is unsustainable in the long run," Gensler told the Global Financial Markets Association.

Financial market participants and operators are considering potential Libor replacements based on real transactions. These include overnight index swaps rates, benchmark rates based on actual short-term collateralized financings or a new standard based on government borrowing rates, Gensler said.

While any decision to phase out the Libor system could be unpopular, no financial benchmark should be "too big to replace," he said.

"I believe the best way to promote both market integrity and long-term stability is by ensuring that benchmarks are reliable and honest," said Gensler. "I recognize that change can be hard, but change is also a natural part of life."

Source: http://www.usatoday.com/story/money/business/2013/02/28/gensler-criticizes-libor-system/1953441/

Dollar-Funding Stress Falls as Libor Declines to Year’s Low

Money-market indicators showed short-term dollar funding stress declined as the rate banks in London say they can borrow from each other reached a low for the year.


Three-month London interbank offered rate, or Libor, which represents the rate at which banks say it would cost to borrow from another, fell to 0.2796 percent, the lowest since Aug. 9, 2011, according to the British Bankers’ Association. The Libor- OIS spread, a gauge of banks reluctance to lend, narrowed to 13.9 basis points from 14.8 basis points yesterday.

Overnight index swaps, or OIS, give traders predictions on where the Fed’s effective funds rate will average for the term of the swap. The central bank’s target rate is set in a range of zero to 0.25 percent.

Predictions in the forward market for Libor-OIS, known as the FRA/OIS spread, fell to the lowest since October, at 15.1 basis points, according to the second rolling three month contracts.

The difference between the two-year swap rate and the comparable-maturity Treasury note yield, known as the swap spread, narrowed 0.13 basis point to 13.6 basis points. The gap is a gauge of investors’ perceptions of U.S. banking sector credit risk as swap rates are derived from expectations for dollar Libor.

Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.

The seasonally adjusted amount of U.S. commercial paper rose $200 million to $1.0631 trillion in the week ended Feb. 27, according to Federal Reserve data.
Euribor-OIS Spread

The cost for European banks to convert euro-denominated payment streams into dollars-based funding via the cross currency swaps market increased. The three-month cross-currency basis swap was 18.1 basis points below Euribor, from 17.1 basis points below yesterday.

Foreign-exchange swaps are typically for periods of less than a year, while cross-currency basis swaps usually range from one to 30 years. The latter are agreements in which a person borrows in one currency and simultaneously lends in a different currency. The trade involves the exchange of two different floating-rate payments, each denominated in a different currency and based on a different index.

The Euribor-OIS spread, the difference between the euro interbank offered rate and overnight indexed swaps, was little changed. The measure of banks’ reluctance to lend to one another was 13 basis points.
Repo Rates

The overnight Treasury general collateral repurchase agreement rate opened today at 0.24 percent, according to ICAP Plc, the world’s largest inter-dealer broker.

The average rate for borrowing and lending Treasuries for one day in the repo market was 0.168 percent yesterday, according to a GCF repo index provided on a one-day lag by the Depository Trust & Clearing Corp.

Securities dealers use repos to finance holdings and increase leverage. Securities that can be borrowed at interest rates close to the Fed’s target rate are called general collateral. Those in highest demand have lower rates and are called “special.”

The average rate for overnight federal funds, known as the fed effective rate, was 0.15 percent yesterday. The rate opened today at 0.16 percent. The effective rate is a volume-weighted average of trades between major brokers for overnight funds, reported on a day lag by the Federal Reserve Bank of New York.

Source: http://www.bloomberg.com/news/2013-03-06/dollar-funding-stress-falls-as-libor-declines-to-year-s-low.html

Libor: CNBC Explains

If you’ve read financial news in the last few years, you’ve come across the term Libor. Libor is the London InterBank Offered Rate, a key interest rate used by banks for short-term lending with other banks. For those who are fuzzy on the topic, Salman Khan of the Khan Academy explains what Libor is and how it is used.

From this video, you’ll understand:

• How Libor is calculated
• How this differs from the Federal Funds Rate
• Why banks use Libor

Source: http://www.cnbc.com/id/43266422

What Was Libor?

Matt Levine at Dealbreaker points out something that I had never quite realized: A lot of smart people believed that Libor was the risk-free rate of interest.


The Libor scandal has always puzzled me in part because I grew up believing this:

There is a small chance that an AA-rated financial institution will default on a LIBOR loan. However, they are close to risk-free. Derivatives traders regard LIBOR rates as a better indication of the "true" risk-free rate than Treasury rates, because a number of tax and regulatory issues cause Treasury rates to be artificially low. To be consistent with the normal practice in derivative markets, the term "risk-free rate" in this book should be interpreted as the LIBOR rate.

That quote is from 2006, and looks sort of adorably naive now—banks are close to risk-free! and AA-rated for that matter!—but the guy, as the saying goes, literally wrote the book on derivatives. In financial markets, pre-crisis, Libor (and Euribor) was less "the rate at which banks borrow from each other" (or "the rate at which banks don't borrow from each other") and more "the risk-free rate for discounting stuff."

Plenty of people – in derivative markets, but also lots of people who borrowed using Libor—thought of Libor that way: it was just "the interest rate," intended to be risk-free. Making it relatively insensitive to big-bank credit would be, on this theory, a feature, not a bug.

In other words, if you think that Libor is supposed to be just a measure of the risk-free rate of interest, then having people manipulate it during a crisis so that it did not accurately reflect the market view of risk in bank lending is not a big deal. The manipulators were helping Libor stay risk-free.

What strikes me as so odd about this view is that I never, ever encountered it in the entire five years or so I spent arranging gargantuan Libor loans.

I was a corporate lawyer at a couple of the biggest law firms in the United States and my specialty was leveraged loans. Every single loan I lawyered was a Libor loan. No one ever communicated to me their view that Libor was meant to be risk free.

Our credit documentation made it very clear that we used Libor because it was usually pretty good at reflecting the cost of funding for banks. Since these loans were usually syndicated and held by a broad group of banks, it was simpler to use Libor than to calculate the funding costs for each bank separately. And, usually, the market didn't charge different banks very different rates anyway.

But we had a sneaky clause in our credit agreements that made it very clear that what borrowers were going to pay was the cost of funding or Libor, whichever was higher. That clause said that if for some reason some of the lender's cost of funding was significantly higher than Libor, the borrower was going to pay that higher cost of funding.

That's right. If a bank's cost of funding went up idiosyncratically, the borrower got penalized. If a bank was suddenly considered a big credit risk, it's borrowers paid the premium.

This, to me, demonstrated that we were using Libor because it usually reflected the cost of funding. But, apparently, folks in the derivatives world had a very different view of things.

Source: http://www.cnbc.com/id/100501839/What_Was_Libor