LIBOR 101: Why you should care

This story was updated on July 3, 2012

(MoneyWatch) A scandal at Britain's Barclays bank has led to the resignation of the chairman, the CEO, and the chief operating officer and put an obscure financial term in the headlines: Libor, which stands for the London Inter-Bank Offered Rate. It's the daily interest rate that banks charge each other for short-term loans, but it also can affect consumer loans.

Under an agreement announced last week, Barclays and its subsidiaries will pay about $453 million to settle charges that they tried to manipulate Libor.  Barclays is one of several major banks reportedly under investigation. The scandal prompted Barclays bank chairman Marcus Agius to step down Monday, and cost CEO Bob Diamond his job Tuesday.

Why should you care about this seemingly esoteric interest rate?

LIBOR is one of the standard interest rates used to establish consumer interest rates on credit cards, adjustable rate mortgages, interest-only mortgages and many small business loans. (LIBOR was also used to establish the base price for credit-default swaps, the instrument that helped ignite the 2008 financial crisis.) Lenders earn money by offering consumers the LIBOR rate, plus some extra amount, often expressed as "LIBOR +1" or the LIBOR rate + one percent. That means that as LIBOR moves up or down, it can change the amount you pay every month to service your debt.

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Given LIBOR's importance to interest rate markets and lending to consumers and businesses, regulators were more than a little miffed when they learned that Barclays PLC attempted to manipulate the market. The $453 settlement was the largest ever for the U.S. Commodity Futures Trading Commission (CFTC).

According to the CFTC, Barclays based its proposed settings for the Libor on the requests of its derivatives traders who wanted to manipulate the rate to benefit their trading positions. The Associated Press reported that the CFTC released a May 2007 email from a Barclays trader in New York that said, "Pls. go for 5.36 Libor again tomorrow, very long and would be hurt by a higher setting ... thanks."