It is an open secret in the banking world: the interest rates for many mortgages and loans are based on a benchmark that is largely guesswork.
The flaws in the rate-setting process, which is used to determine the pricing for trillions of dollars of financial products, have been exposed by the latest banking scandal. Regulators around the world are investigating whether big banks gamed the rates for their own benefit before and after the financial crisis.
But even if banks do not deliberately manipulate the rates, the benchmark remains vulnerable.
Banks derive the rates from estimates rather than real market data. So the benchmark, a measure of how much banks charge each other for loans, does not necessarily represent actual borrowing costs. This weakness has only been exacerbated in recent years, as banks have mostly stopped lending to each other.
The Federal Reserve chairman, Ben S. Bernanke , told Congress this week that he did not have “full confidence” in the process, calling it “structurally flawed.”
The troubles center on a key benchmark known as the London interbank offered rate, or Libor . This rate and its variants are used to determine the prices for mortgages and other loans, and play a critical role in the multitrillion dollar market for financial contracts called derivatives.Page 1 of 7 | Next Page