LIBOR Hits ‘Home’ as Litigation Steams Ahead

By Maggie Tamburro
LIBOR has become a household name – quite literally.

Residential borrowers with adjustable rate mortgages based on the London Interbank Offered Rate (LIBOR) are the latest group to claim they were taken for a ride in the form of costlier mortgage payments due to alleged rigging of the now infamous benchmark. On the heels of other class actions (filed by the likes of local governments, community banks, and investors), homeowners have filed a high-profile class action lawsuit in New York District Court naming as defendants twelve banks they say were involved in the alleged rigging of LIBOR.

Like a runaway train, the LIBOR scandal is gathering steam, and where it will stop is anyone’s guess. LIBOR has been making headlines since this summer’s quiet announcement that Barclays agreed to pay over $450 million in settlement to U.S. and British regulators over allegations it participated in manipulation of LIBOR. And while many in the financial industry have suspected LIBOR-rigging for years (some claim manipulation has been ongoing for over a decade), most of the country seemed underwhelmed with news reports on such an esoteric topic.

Prior to this class action, much of the LIBOR litigation centered around investors claiming they lost out when LIBOR was allegedly set too low during the financial crisis – making banks allegedly appear healthier than they really were and positioning some investor/creditors for lower profits.

For Some Borrowers, LIBOR a Little Too Close to ‘Home’ …

However, the latest class action, filed October 4, 2012, alleges LIBOR-rigging hit some residential borrowers much closer to home – in the form of costlier mortgage payments paid by plaintiff borrowers on real estate loans in which plaintiffs mortgaged their residences. The action, which involves adjustable rate mortgages with interest rates indexed to LIBOR, alleges that defendant banks artificially fixed or increased LIBOR between 2000 and 2009 to higher rates on days the adjustable mortgage interest rates were “reset,” resulting in increased mortgage costs to borrowers due to over-inflated rates.

Plaintiffs claim the alleged LIBOR-rigging had a ripple effect, benefiting defendants in the secondary market by increasing their “spread” - the profit on the amount paid to investors via various collateralized securities comprised of the plaintiffs’ LIBOR-indexed loan instruments and the amount collected from the plaintiffs/debtors.

The suit has potential for far-reaching implications. By some accounts, nearly two million U.S. mortgages, mainly comprised of subprime adjustable rate mortgages, are indexed to LIBOR.

LIBOR

Generally speaking, LIBOR is a global benchmark banking institutions use to set the interest rates which banks use for inter-bank lending. The number of banks participating in the panel that sets LIBOR varies, reportedly fluctuating from as few as sixteen banking institutions in 2008 to as many as twenty in 2011.

Although frequently referred to as one figure, LIBOR is actually a collection of rates produced for ten currencies and fifteen maturities. In a process overseen by the British Bankers’ Association, each London business day a panel of prominent global banks submit what the banks estimate they would pay to other banks to borrow in a certain currency and for a certain period of time. The top and low figures are removed, and the remaining estimates are averaged to calculate LIBOR quotes, which are then published by Thomson Reuters.

The bottom line: LIBOR profoundly affects our global financial system. According to a BBC report released in October, LIBOR is one of the most critical interest rates in global finance, used to set a range of financial transactions worth an estimated $300 trillion - equal to about four and a half times the global GDP.

LIBOR benchmarks are used in a vast array of financial instruments, including interest rate derivatives which allow speculation on interest rate risk, such as short-term interest rate futures contracts, and a variety of interest rate swaps and inflation swap agreements, to name a few.

LIBOR is a common measure for short term interest rates globally, and very frequently is used as the index for adjustable rate mortgages in the U.S.

This brings us back to the latest class action filed by homeowners. The action is unique in that it’s brought by borrowers involved in the primary market (where, very broadly speaking, securities are created) as opposed to those in the secondary market (where securities are traded).

How did this esoteric, largely self-reporting, somewhat unregulated benchmark become such a prominent global force capable of wielding so much power in the global financial system?

Perhaps part of the reason is the complexity of many of the concepts involved in LIBOR - not the least of which include the way it is reported, the manner in which it is calculated (up to five decimal places), its functionality and versatility in the financial marketplace, the number of ways in which it can be used, and the vast array of financial instruments which utilize it.

How Far Will The Effects of LIBOR-related Litigation Reach?

Predictions differ across the board. However, lawsuits could skyrocket if class actions like this one filed by homeowner/borrowers are certified, or if the ripple effect of those affected by the alleged rigging continues to spread, bringing in additional indirect market participants at varying levels of marketplace involvement.

Some commentators opine that the future of LIBOR-related litigation may be limited by jurisdiction, privity, or other such legal-specific issues, but that opinion seems to contemplate more investor-type actions, rather than the kind of primary market losses alleged here.

At least one recent report, released in the UK in September of this year, has suggested that the rate-setting involved in LIBOR should be perhaps be better regulated, and the use of alternative benchmarks for certain financial products considered. Other commentators have recommended sanctions be strengthened.

Do you think alternative benchmarks should be used for certain kinds of financial derivatives?

Are stiffer LIBOR regulations and/or sanctions in order?  Or alternatively, do you think the manner in which LIBOR is currently utilized and reported would be undermined by additional regulation?
Avatar

Maggie Tamburro

Maggie Tamburro is an attorney and writer who holds a Juris Doctor from The John Marshall Law School and a Bachelor of Arts from the University of Texas. She was admitted to the Illinois Bar in 1994 and Florida Bar in 1999 and has significant experience in legal research, editing, and writing. Maggie is active her in local community, holding various publicly appointed civic board positions.

Get the best expert

Fill out the form and one of our representatives will be in touch with you shortly. Or, you can call or email us directly.