Libor: Winners and losers

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Were mortgage borrowers winners or losers in the Libor scandal?

As shocking as it may sound, it’s possible that some borrowers benefited from banks lying. It’s a weird but valid theory.

In case you haven’t heard, some of the world’s largest banks are under investigation for allegedly trying to manipulate the Libor rate from 2005 through 2009. Barclays has admitted wrongdoing and said it’s not alone in the rate-fixing scheme.

If banks were successful in manipulating the Libor, it is possible that  borrowers with adjustable-rate mortgages, or ARMs, paid too much or too little in interest, depending on when their loans reset.

About 2 million ARM loans were tied to the Libor rate as of March, according to Guhan Venkatu, an economist with the Federal Reserve Bank of Cleveland, based on data provided by Lender Processing Services, or LPS. In 2008, most subprime ARMs and about 60 percent of prime ARMs were tied to the Libor.

“I suspect that it was random as to whether people with loans tied to the Libor were helped or hurt,” says Dean Baker, co-director of the Center for Economic and Policy Research, in Washington, D.C.

It appears that, initially, lenders tried to push the Libor up. During the financial crisis, they wanted to push rates down.

Was your loan affected?

If you don’t know whether your ARM loan was tied to the Libor, you can look at your mortgage note or other loan documents. If the note says your rate was based on an index, keep reading and look for the word Libor or London Interbank Offered Rate.

Hint for winners

If your loan reset during the financial crisis, it’s possible that your loan had an artificially low rate.

“During the crisis (the banks) systematically understated their Libor in order to convince investors that they were not as stressed as they actually were,” Baker says. “This would have benefited borrowers.”

Why would banks lie to give you a lower rate?

They wouldn’t. Lenders didn’t go through all that trouble to give you break on your loan. They simply had bigger assets at stake and bigger problems to deal with at the time. The gains or losses mortgage borrowers incurred during this mess was simply collateral damage of a much bigger operation.

“The purpose of the manipulation was not to make more money on mortgages,” Baker says. “They were trying to win on their bets on derivatives. They didn’t care about the impact on mortgages.”

Some experts say it is unlikely that banks were successful in manipulating the rate, unless several of them conspired to push the rate in the same direction. I explained why in a previous blog.

But the more I think about this, the more I doubt lenders would go through the trouble of cheating if they didn’t think the game would work.

I’m not alone.

From a Bloomberg story:

“It is far easier to manipulate Libor than it may appear,” says Andrew Verstein, a lecturer at Yale Law School, in a paper to be published in the winter 2013 issue of the Yale Journal on Regulation. “No conspiracy is required.”