Libor Rate History Compared to Fed Funds Rate

How the Rate Banks Charge Each Other Warns of Crisis

Libor History
•••

Getty Images / Comstock Images

The history of the Libor rate has shown it is usually a few tenths of a point above the fed funds rate. Libor is the interest rate banks charge each other for short-term loans. When it diverged from the fed funds rate in September 2007, that signaled the financial crisis of 2008.

Libor is short for London Interbank Offered Rate. Originally, London banks in the British Banking Association published it as a benchmark for global bank rates. In January 2014, the InterContinental Exchange took over its administration. That's because the BBA was found guilty of price-fixing. The rate-fixing inquiry revealed how banks manipulated interest rates for their own gain.

Historical Libor Interest Rates

The table below shows a snapshot of the historical Libor rates compared to the fed funds rate for each year, as of December 31, since 1986. Pay particular attention to the Libor rates during the period of April 2008 to June 2009, when it diverged from the fed funds rate.  

In April 2008, the 3-month Libor rose to 2.9 percent even as the Federal Reserve lowered the fed funds rate to 2 percent. That was after the Fed had aggressively dropped the rate six times in the previous seven months. The current fed funds rate has returned to more normal levels.

Why did Libor suddenly diverge from the Fed's interest rate target? Banks started to panic when the Fed bailed out Bear Stearns. It was going bankrupt due to investments in subprime mortgages. Throughout the spring and summer, bankers became more hesitant to lend to each other. They were afraid of the collateral that included subprime mortgages. Libor rose steadily to indicate the higher cost of borrowing.

On October 8, 2008, the Fed dropped the fed funds rate to 1.5 percent. Libor rose to a high of 4.8 percent on October 13. In response, the Dow fell 14 percent in October.

By the end of 2009, Libor returned to more normal levels thanks to Federal Reserve measures to restore liquidity

Since 2010, Libor has steadily declined to be closer to the fed funds rate. From 2010 to 2013, the Fed used quantitative easing to keep rates low. It bought U.S. Treasury notes and mortgage-backed securities from its member banks.

In the summer of 2011, the Fed announced Operation Twist, another form of quantitative easing. Despite this easing, the Libor rate rose in late 2011. Investors grew concerned about potential debt defaults from Greece and other contributors to the eurozone debt crisis.

In late 2015, Libor began rising again. Investors anticipated that the Federal Open Market Committee would increase the fed funds rate in December. The same thing happened in 2016. 

3-Month Libor Compared to Fed Funds Rate Chart

Date Fed Funds Rate 3-Month LIBOR Rate
Dec 31 1986 6.00 6.43750
Dec 31 1987 6.88 7.43750
Dec 30 1988 9.75 9.31250
Dec 29 1989 8.25 8.37500
Dec 31 1990 7.00 7.57813
Dec 31 1991 4.00 4.25000
Dec 31 1992 3.00 3.43750
Dec 31 1993 3.00 3.37500
Dec 30 1994 5.50 6.50000
Dec 29 1995 5.50 5.62500
Dec 31 1996 5.25 5.56250
Dec 31 1997 5.50 5.81250
Dec 31 1998 4.75 5.06563
Dec 31 1999 5.50 6.00375
Dec 29 2000 6.50 6.39875
Dec 31 2001 1.75 1.88125
Dec 31 2002 1.25 1.38000
Dec 31 2003 1.00 1.15188
Dec 31 2004 2.25 2.56438
Dec 30 2005 4.25 4.53625
Jan 31 2006 4.50 4.68000
Mar 28 2006 4.75 4.96000
May 10 2006 5.00 5.16438
Jun 29 2006 5.25 5.50813
Sep 18 2007 4.75 5.58750
Oct 31 2007 4.50 4.89375
Dec 11 2007 4.25 5.11125
Jan 22 2008 3.50 3.71750
Jan 30 2008 3.00 3.23938
Mar 18 2008 2.25 2.54188
Apr 30 2008 2.00 2.85000
Oct 8 2008 1.50 4.52375
Oct 29 2008 1.00 3.42000
Dec 16 2008 0 2.18563
Mar 31 2009 0 1.19188
Jun 17 2009 0 0.61000
Dec 18 2009 0 0.25125
Dec 31 2010 0 0.30281
Dec 31 2011 0 0.58100
Dec 31 2012 0 0.30600
Dec 31 2013 0 0.24420
Dec 31 2014 0 0.25560
Dec 31 2015 0.50 0.62000
Dec 31 2016 0.75 0.99789
Dec 29 2017 1.50 1.69248

Source: "Historical Fed Funds Rate," Federal Reserve. "Historical Libor Rate," Federal Reserve.)

Early History

In the 1980s, banks and hedge funds began trading options based on loans. The derivative contracts promised high returns. There was just one hitch. Both parties had to agree on the interest rates of the underlying loans. They needed a standard method to determine what a bank would charge for a future loan.

That's when the British Banking Association stepped in. In 1984, it created a panel of banks. It asked them what interest rate they would charge for various loan lengths in different currencies. Banks could now use the results to price derivatives.

The actual survey question was, "At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11 am?"

On September 2, 1985, the BBA published the predecessor to Libor.  It was called BBAIRS, short for the British Bankers Association Interest Rate Swap. In January 1986, it released the first Libor rates for three currencies: the U.S. dollar, the British sterling, and the Japanese yen. 

The BBA responded to the 2008 financial crisis by modifying its survey question. It asked panel members, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 a.m.?" The question was more realistic. It gave better results by asking the bank what it could actually do, rather than what it thought.