The news on Wednesday that cities and states are suing some of the world's largest banks over Libor manipulation shows how this scandal could blow up into one of history's biggest bank frauds.
That's because interest-rate manipulation might well have kept your town or state from hiring firefighters or teachers, from paving roads or paying for indigent care or after-school programs for your kids -- adding to the human suffering of the economic collapse these same banks caused in the first place.
If it's any consolation, the lawsuits and fines over this manipulation could potentially cost the banks -- which include not only Barclays but Bank of America, JPMorgan Chase, Citigroup, and many more -- billions of dollars.
"This could get very ugly in a hurry for some banks," Peter Tchir of TF Market Advisors wrote in a note.
And this could finally be enough to make Americans stop reacting to the Libor scandal with "a shrug," as Joe Nocera recently put it, and push them closer to believing what Robert Shapiro, founder of economic advisory firm Sonecon, calls possibly "the biggest financial fraud in history."
LIBOR rates are a very big deal, because they are benchmarks for countless other interest rates. The majority of adjustable rate mortgages, for example, are set at a LIBOR rate plus 2 or 3 percentage points. So are millions of student loans, auto loans, and credit card finance charges. LIBOR rates also are used to set or reset small business loans, futures contracts, and interest rate swaps. All told, an astonishing $360 trillion in loans around the world are indexed to LIBOR. That is more than five times the value of the world’s entire GDP
this year.

One reason that LIBOR has such a far reach is that there are numerous LIBOR rates for different purposes. Each rate has a time frame — rates for loans one day from now; one month, three months and six months out; one year, five years and ten years from now, and so on. There are 15 such time frames, all told. In addition, separate LIBOR rates also are provided for dollars, Euros, yen, and seven other currencies. The integrity of these LIBOR rates, however, depends entirely on the honesty of banks reporting the rates they actually would to expect to pay. Inevitably, we got what we should have expected.
So, when Barclays (and almost certainly others as well) had investments that paid off, or simply paid off more, when interest rates rose, it simply reported a higher figure to LIBOR in order to nudge up the average. And that usually led to higher interest rates for millions of other businesses and people with loans indexed to the LIBOR. Sometimes, it worked the other way. In late 2008, Barclays (and probably others) low-balled the rates they reported for LIBOR averaging. The purpose was to make themselves look sounder than they actually were, since they expected to borrow at low rates. They presumably figured that might reassure their shareholders and perhaps even dampen public demands for tighter regulation.
For several years, academics and a number of market followers warned that something funny was going on with LIBOR. The evidence was not hard to find. For example, the “spread” or difference between U.S. Treasury rates and LIBOR rates for loans of the same time frame began to widen. From 2000 to 2006, LIBOR rates averaged one-quarter of one percentage point above Treasury rates, and the two rates moved up and down together in lock step. In 2007, however, that spread more than doubled to nearly two-thirds of a percentage point, and their movements up and down did not track each other so closely. By 2008, the difference in the rates was five times what it was in 2000–2006, averaging 1.3 percentage points, and the up-and-down movements of the two rates no longer tracked each other.