As President Obama prepared to tout social mobility and equitable economic growth at the State of the Union, a Federal Reserve Board Governor he appointed said more changes are needed to a deep-penetrating system that was, in recent years, infamously manipulated by Too Big To Fail banks around the world.
Speaking at the Brookings Institution on Tuesday morning, Jerome Powell said that the London interbank offered rate (LIBOR) is still unreliable, and revealed that the Fed and “a group of the largest global dealers” has formed a panel to find an alternative to the index. The measurement, as it currently stands, he said, encourages bad behavior, and poses a massive systemic risk.
“LIBOR is huge–there are roughly $300 trillion in gross notional contracts that reference it–so the incentives to manipulate it still remain in place,” he said, though he added that bankers filings that determine LIBOR are “now subject to careful monitoring.”
Powell also noted transactions that determine LIBOR are decreasing, and said a continuation of the trend could create new headaches for regulators and the judicial system. He did note that the body overseeing LIBOR is considering altering its input formula “so that it can be based as much as possible on actual arm’s-length transactions from a broader base of funding transactions.” But, he stated, if the overall publication of the benchmark becomes unfeasible, then “untangling the outstanding LIBOR contracts would entail a legal mess that could endanger our financial stability.”
Since 2008, it has been reported that the world’s biggest banks fraudulently altered information that affected LIBOR–activity that has led regulators around the world to levy billions of dollars in penalties on financial institutions.
The rate is calculated through a daily poll that asks 18 banks to estimate its borrowing costs. It is, in turn, used by financial institutions to determine consumer interest rates.
Read Gov. Powell’s remarks here.
