LIBOR (the acronym used for the London Inter-bank Offered Rate) is currently under close scrutiny from global financial watchdogs, including the Canadian Competition Bureau (CCB), with competition authorities from the U.S. expected to join the fray soon.
Although set in London by the British Banker’s Association (BBA), LIBOR commands significant influence over global financial markets, including those directly affecting California real estate financing. LIBOR is an interest rate set daily by the BBA, based on estimates of what it costs banks to borrow cash from one another.
In essence, LIBOR sets the benchmark for the inter-bank cost of funds and is used almost pervasively in global financial markets for setting rates on a multitude of different financial dealings. In the U.S., and in the real estate market particularly, LIBOR is the benchmark rate set for the pricing and daily fluctuations in many adjustable rate mortgages (ARMs).
Recent scrutiny of the LIBOR was triggered in 2008 when market perceptions of financial risk began soaring, sending interest rates through the roof, yet the LIBOR remained static and did not respond to the explosion of panic in financial markets. The anomalous refusal of the LIBOR to adjust upwards during what we now know to be the greatest global financial crisis since the Great Depression has caused many regulators and watchdogs to suspect foul play.
Such foul play could result from any number of sources. It is widely suspected that bankers who had influence over the setting of the LIBOR rate regularly strategized ways to manipulate it — an instance of collusion that is in strict violation of antitrust rules.
Since LIBOR is used as a global financial benchmark, a manipulation of the LIBOR rate that does not reflect current levels of risk in financial markets could lead to disastrous consequences, not just for mortgage borrowers in the U.S. but also for the entire global banking system.
first tuesday take
There are two obvious take-aways from this news:
- stay away from ARMs (unless you know exactly what you’re doing with extreme sophistication); and
- the so-called imperative of lender “self-regulation” is patently false.
first tuesday has long-maintained that ARMs are a complex financial instrument to be avoided by homebuyers and only used by the most savvy and informed real estate buyer (they are typically used by investors looking to make quick flips). The LIBOR news is just one more reason to watch your back when considering financing a real estate transaction with an ARM.
More significantly, this news lays bare the realities of self-regulated banking: time and again (2008 comes to mind?) the apparently rational market is supposed to self-correct and auto-police since all involved are working with their own best interests in mind. But if this principal has not broken down and been disproven already, it just might if this report about LIBOR is accurate. The fact is, there are people pulling the strings, people with power, and we are not talking about regulators.
We are talking about a group of bankers who manipulated a rate relied upon by the entire financial world as a benchmark for setting their consumer interest rates — a rate which should ultimately reflect the current level of risk on the market. If the LIBOR is low, risk is perceived to be low, and thus an entire chain of cash flows and transactions are made all completely depending on what one group of bankers have stated is their best estimate for the cost of funds.
We aren’t being Chicken Little here, but if robust regulation by objective third parties does not occur globally, then it won’t just be the sky of California real estate that falls (again).