Sunday School

From Business Week: The Lowdown on Libor.

Financial institutions the world over use Libor—short for the London interbank offered rate—to set the interest paid on everything from mortgage loans to complex financial instruments.

What's the recent controversy about?

With the aftereffects of the credit crunch lingering, a high Libor, especially relative to U.S. Treasuries, would set off alarm bells that capital-starved financial institutions are still at risk for further meltdowns, says market research firm Global Insight's Brian Bethune. Some industry insiders have accused the banks of quoting falsely low rates for the surveys in order to force down Libor and paint a rosier picture of the lending environment. It's more likely that the banks are simply reporting their best rates, not the rate at which they're most commonly lending, Bethune says. The BBA is conducting what it calls "a regular review," with results due May 30. In the meantime, proposals have been offered to ensure Libor's accuracy, from surveying more banks to ditching Libor in favor of an alternative rate.

The EE isn't quite sure when LIBOR turned into Libor (maybe the limp-wrist journalists have trouble writing capital letters?) but since he was, many moons ago, educated in a Catholic school, he will explain this supposed "paradox" in the form of a "parable".

"If the EE sold you the first burrito for $0.01, and all subsequent ones for $1,000, and you ABSOLUTELY had to eat 4 burritos or die, would you say that the burrito cost you $0.01, or was the true cost closer to $750?"