LIBOR grew out of the same ecosystem that created Eurodollars. Originally a Eurodollar was simply a dollar held in a non-US domiciled bank, in particular a ban

LIBOR grew out of the same ecosystem that created Eurodollars. Originally a Eurodollar was simply a dollar held in a non-US domiciled bank, in particular a bank outside of the Federal Reserve System. The story, at least partly true, is that the Soviet Union was making a ton of money selling oil. Thanks to OPEC, the market for oil is denominated in dollars. Soviet oil companies didn't mind the dollars, but they didn't want money in US banks, and so the Eurodollar was created. In the USD money market (the interbank lending market for terms < 12 months) the most riskfree rate is the Fed Funds rate -- that is the rate which banks lend to ach other within the Fed system. In the money market for USD, everything was quoted in terms of Fed Funds, e.g. Fed Funds + 50 etc. Banks with EuroDollar deposits couldn't partake in the Fed system, but they needed something similar, and so LIBOR was created. Well, then it grew. US banks got involved in EuroDollars and foreign banks got US subsidiaries and everything kind of ballooned. But the big change was the invention of interest rate swaps. Interest rate swaps create a linkage between the Money Market (terms < 12 months) and the Capital Market (terms > 12 months). There are a bunch of economic explanations as to why interest rate swaps exist and some of them have to be true, but they're irrelevant to the LIBOR story. A vanilla fixed-floating swap needs a floating rate, and that's LIBOR. A couple of trillion dollars (notional) worth of derivatives later, instead of simply being a pragmatic way to quote rates in the money market, it then drove P&L of derivatives desks. I think everyone knew the potential for manipulation was always possible, but for a long time I think, until the tail started wagging the dog, it worked. But there's no going back now.