Amid the investigations into manipulation of Libor, policymakers are coming around to the idea that the world needs a new benchmark to price hundreds of trillions of dollars in loans, securities, and derivatives. The challenge will be getting banks, investors, and borrowers to agree on what that benchmark should be.
Libor’s flaws are now abundantly clear. Instead of gleaning information from actual transactions, Libor relies on banks to report their borrowing costs honestly, something they spectacularly failed to do. And the market it supposedly measures—interest rates on short-term loans among banks, unsecured by collateral—tends to disappear in times of crisis, making the rates no more than estimates.