Why LIBOR is so widely used?

musicgold1 · August 5th, 2009, 6:49 pm

Hi,I am trying to understand why the LIBOR is so widely used and quoted in American credit markets / business transactions. It is quoted in transactions ranging from bank loans taken by small companies to multi-billion dollar SWAPS. I know that the LIBOR is set by a bunch of banks headquartered in London, using their dollar deposits/funds to lend each other. However, I dont know how this presumably small portion of the dollar market (i.e. London based banks) influences the much bigger portion of the dollar market (that is the US financial system itself).Thanks,MG.

rmax · August 6th, 2009, 6:39 am

Don't know for sure but would be surprised if the dollar turnover is smaller in the US than in Europe. Also the US basis most of trades in dollars where London has a number of other currencies to contend with. Furthermore it is probably historical based on the limits around trading Eurodollars.Finally most of the stuff I see is now proved a Fed-Open (however not credit). This causes an issue when you have a european entity quoting LIBOR and the US entity quoting Fed Funds - causes around a 20bp basis (although I think this has narrowed recently).

Martinghoul · August 6th, 2009, 6:58 am

It's all about the history... You can google and read some articles on how the dominance of LIBOR got established, as there are some rather interesting stories.LIBOR is set by a bunch of banks, but I don't know if I would agree that they're headquartered in London. After all, BoA, Citi, JPM and RBC are all on the panel.

acastaldo · August 13th, 2009, 4:59 pm

Martinghoul is rite. The LIBOR market got established in the first place to get around US govt regulations such as the Interest Equalization Tax of 1963 and the Voluntary (ROFL!) Foreign Credit Restraint of 1965, etc. etc. It serves a a kind of free market oasis beyond the reach of the us authorities.

C3I2 · August 14th, 2009, 12:55 am

Interest Equalization Tax was a domestic tax measure implemented by U.S. President John F. Kennedy in July 1963. It was meant to make it less profitable for U.S. investors to invest abroad by taxing the interest on foreign securities.That would make John F. Kennedy a commie mercantilist, right?

freddiemac · August 14th, 2009, 2:39 pm

Yes the off shore market was established in order to avoid US regulations such as Regulation Q (see eg Stigum's Money Market for a brief explanation). To a small extent USD off shore markets was developed due to the fact Warzaw pact countries (USSR and others) and oil producing countries with bad relations with the US (who got USD when selling oil) held USD but were unwilling to place them in the US since they were afraid that the government might take them or place restrictions on them. This is NOT the main explanation but just an interesting side story.

acastaldo · August 15th, 2009, 4:55 pm

Quotecommie mercantilistExactly right, only in the United States they generally refer to them as "democrats".

musicgold1 · August 27th, 2009, 11:29 am

According to this article,LIBOR gained popularity in the United States as international investors in mortgage debt wanted to use a rate more in line with their cost of doing business in global markets.