The Libor scandal and what it means to us.

The fixing of the Libor rate has been big news lately. But what does it mean to us? It means a lot. Lets start by stepping back and looking at the U.S. Banking system. Banks use the prime rate and the fed funds rate in order to lend to each other. The prime rate is also used to set rates that banks use commercially. Remember that in Banking the accounting system is reverse of what it is in business. So if you get money it is a credit and not a debit. The thinking being money is a liability as it is not out there working for you. So Banks want to loan out money.

Enter the "pesky" Federal Reserve Bank. The Fed says that you have to have X % of your assets in money in your bank at days end in order to be considered solvent. If you loaned too much or did not get money in you thought you would you have to go out and buy money. You buy, for the most part, at the fed funds rate from other banks. Now this rate moves every day. If you go out to early to buy others know you need money and you are going to pay more for it. If you are lending you want to trickle money out so you get the most for it.

Libor does much the same as Fed funds and prime combined but on a global scale. Libor rates are set differently than ours. The central bank of England looks at a high and low interest rate averages it out and says this is what libor is supposed to be. This method of setting rates has led to traders doing each other "favors" and fixing the libor rate.

You should care for a few reasons. If you have a mortgage and the rate is pegged to libor and the rate is fixed high then you pay !!!! If you have money in some banks and are buying bank stock and the rate is fixed low then you may believe the bank is in good shape. Remember the higher the rate the more a bank needs the money. If you are business planning an expansion and need to borrow money you may be looking at the market to determine based on the market, not what traders fixed, when is the best time to borrow. For those of you wondering the federal reserve did point of to the bank of England problems it saw in the way libor was calculated . But nothing was done.

Markets today are global and move at the speeds never seen before. We can see our governement trying to regulate them. These attempts are often ham fisted and often miss the mark.  But on the other hand we do need to be protected from the non free "free" market