What is Libor? Answers to interest-rate questions

Here are some questions and answers to help make sense how this interest rate, known as Libor, may affect your household:

Q. What is Libor?

A. Libor, an acronym for the London Interbank Offered Rate, is the interest rate at which large international banks are willing to lend each other money on a short-term basis. It's calculated every business day in 10 currencies and 15 terms, ranging from overnight to one year.

Q. How big is its influence?

A. Rates on about $10 trillion in corporate loans, mortgages and student loans worldwide are pegged to Libor, usually with a markup of several percentage points, according to University of Edinburgh professor Donald MacKenzie. The total amount of financial contracts tied to Libor, particularly interest-rate swaps exceeds $300 trillion, or $45,000 for every person in the world.

The rate ended up being calculated in London after President Lyndon Johnson tried to stop dollars from moving overseas in the 1960s. In response, a so-called "Eurodollar" market developed in dollar-denominated deposits held by foreign banks.

The calculation of Libor is so important to the world's financial system that its coordinators have set up dedicated backup phone lines so the number can still be figured out if there's a terrorist attack, MacKenzie wrote in a recent paper in the London Review of Books.

Q. How does it get set?

A. Every business day, more than a dozen banks report to the British Bankers Association their estimates of the rates at which they are able to borrow money from other banks. After discarding the highest and lowest rates reported, BBA staffers average the rest and report the figures daily after 11 a.m. London time. This system, in place since the mid-1980s, has generally worked well, MacKenzie said in an interview. Without a globally accepted benchmark for interest rates there would be "chaos and confusion," he said.