What Libor Means for You
By KIRSTEN GRIND
As regulators investigate whether banks rigged a key interest rate, some of the biggest losers—and winners—might be consumers.
Global banks stand accused of manipulating the London interbank offered rate, or Libor—a scandal that has ensnared at least 16 financial institutions. The British bank Barclays in June paid more than $450 million to settle allegations by U.S. and British authorities that its executives and traders had rigged Libor.
Libor affects private student loans and many other consumer products.
Libor is tied to trillions of dollars in swap agreements and other derivatives—which can affect investors—as well as loans to individuals and businesses. It also often determines payouts to consumers who invest in the $12 trillion U.S. fund industry.
The most-affected products include private student loans
, adjustable-rate mortgages
, money-market funds
and bank-loan funds
. Some business loans and credit cards
also are tied to Libor.
The extent of the problem still is murky. Banks are accused of suppressing Libor during the years surrounding the U.S. financial crisis in 2008, which has been the focus of recent court claims. But the breadth of manipulation and the amount the rate was artificially kept low still isn't clear.
Separately, traders at some global banks are alleged to have colluded to try to manipulate Libor. Their alleged actions may have sent key rates up as well as down, according to regulatory documents. If rates were kept artificially low, borrowers are likely to have benefited from better loan rates, while investors were likely shortchanged on returns, according to experts.
Several big U.S. asset managers, including BlackRock and Vanguard Group, say they are investigating whether their funds have been harmed.
"It's an unbelievable, gargantuan task to figure out," says Eric Jacobson, director of fixed-income fund research at investment researcher Morningstar.
Here is how consumers and investors might be affected:Mutual Funds
Some mutual-fund investors are likely to have been hit by the Libor scandal. A variety of funds invest in securities and other financial instruments with returns tied to Libor. Investors could have been receiving a lower yield than they should have if banks were rigging the rate lower.
Experts say there are some funds that are likely to be more harmed than others.
Money-market funds, with assets of about $2.6 trillion in the U.S., invest in short-term-debt instruments with returns that are sometimes tied to Libor.
Bank-loan funds, which invest in syndicated loans tied to Libor, could also be significantly affected. The funds, which have become increasingly popular, had about $60.9 billion in assets as of June, Morningstar says.
Scott Page, director of bank loans at Eaton Vance says he is closely watching the Libor situation with a particular interest on its effect on bank-loan funds. Mr. Page's team manages $25 billion in bank-loan assets.
"We are almost 100% Libor-based," he says.
In addition, 15 mutual funds with assets totaling $23.8 billion, spread across a variety of categories—such as nontraditional bond funds and alternative funds—use Libor as their primary benchmarks, according to Morningstar. That means their relative performance might have skewed artificially high during the time Libor was suppressed. They range from Goldman Sachs's GS Strategic Income to Pacific Investment Management Co.'s Pimco Floating Income.
Many other funds could have been affected by rate-rigging because they invest in derivatives, and many derivatives have rates tied to Libor. That means investors in bond funds could have been harmed, says Morningstar's Mr. Jacobson.
On the other hand, funds investing in derivatives could have benefited. If a fund entered into an interest-rate swap and paid a floating rate based on Libor, it might have paid less than it should have.
There is little investors can do as regulators and fund companies sort out the extent of the problem. Fund companies could file suit to recoup any losses investors have suffered.
Charles Schwab Corp. one of the largest managers of money-market funds, has taken action already. The company and several of its funds filed three suits in August 2011 against a number of large banks, including Barclays and J.P. Morgan Chase, accusing them of setting Libor artificially low, according to court documents originally filed in the U.S. District Court for Northern California. The banks have filed motions to dismiss the cases.Loans
While investors might have suffered as a result of rate-rigging, some borrowers might have benefited—such as those with adjustable-rate mortgages.
About 9% of all U.S. mortgages, or 4.4 million, are Libor-indexed adjustable-rate mortgages as of February, according to the Center for Responsible Lending. If the rate was rigged higher, however, borrowers could have paid more.
Borrowers of private student loans, whose rates are tied to Libor, also might have received a better deal. Most of the $150 billion in outstanding private student loans have variable rates, says Mark Kantrowitz, publisher of Finaid.org, a financial-aid website.
About 7% of the $116 billion in new student loans issued during the 2011-12 award year are private, he says.
Of course, if borrowers have benefited from lower rates on mortgages and other loans, that means their lenders have suffered—along with investors in bank stocks. New York lender Berkshire Bank recently filed a lawsuit against 16 global banks alleging that it was cheated out of interest income on loans that were artificially suppressed.
Borrowers, however, shouldn't have to worry that they will be forced to make up the difference on an interest rate that should have been lower, experts say.
It would be difficult for lenders to untangle which borrowers were paid when, and at which rate, says Steve Walsh, president of Scout Mortgage in Scottsdale, Ariz. "You can't go backward."