Comparison of Libor Rate Historical Trends with Federal Funds Rate

Libor: A Historical Perspective

One of the key indicators of the financial health of banks is Libor, short for the London Interbank Offered Rate. This is the interest rate at which banks lend to each other for short-term loans. Historically, the Libor rate has typically been slightly higher than the federal funds rate.

However, in September 2007, this relationship shifted, signaling trouble ahead. The financial crisis of 2008 was looming, and the divergence between Libor and the fed funds rate was one of the early warning signs.

Originally managed by the British Banking Association (BBA), the administration of Libor was taken over by the Intercontinental Exchange (ICE) in February 2014 after the BBA was found guilty of price-fixing. The rate-fixing scandal exposed how banks manipulated interest rates for their own benefit.

Historical Trends and Impact

Looking back at the historical Libor rates compared to the fed funds rate since 1986 paints a picture of the changing financial landscape. During the tumultuous period of 2007-2009, when the financial crisis hit, Libor rates peaked as the Federal Reserve lowered the fed funds rate in an attempt to stabilize the economy.

Following the crisis, the Fed engaged in quantitative easing to keep rates low and provide liquidity to the financial system. Despite these efforts, concerns over debt defaults in the eurozone in 2011 led to a temporary rise in Libor rates.

In recent years, Libor fluctuations have been influenced by market expectations of Fed policy decisions. As investors anticipated rate hikes, Libor began to rise once again in late 2015 and 2016.

Early Origins and Evolution

The origins of Libor trace back to the 1980s when banks and hedge funds began trading options based on loans. Derivative contracts relied on standardized interest rate benchmarks to determine future loan pricing. The British Banking Association introduced Libor in 1985 to provide a universal method for pricing derivatives.

Over the years, the methodology behind Libor evolved to reflect the changing financial landscape. The rate-fixing scandal in 2008 prompted revisions to the survey questions used to calculate Libor rates, aiming for more accurate and realistic results.