The Federal Reserve and other regulators in recent years have encouraged financial institutions and corporate treasurers to substitute SOFR for LIBOR, the reference rate for trillions of dollars in mortgages, derivatives, business loans and other financial contracts worldwide.
What will the immediate effects be? Did the banking crisis of 08 have anything do with this?
I think the Libor fixing scandal certainly played a part in moving away from Libor.
Thanks, I had not heard of LIBOR til the other day and I followed the banking crisis of 08. Also I read yesterday their were 3 LIBORs that would remain a little longer then phased out. Now I can’t find the article. The new news on the LIBOR is the retirement date has been changed til June.
So now I am wondering if the recent changes to the Dod Frank rules was why the postponement?
The market responded favorably upon the news.
If there was less fraud under Glass Stegall rules why change if it worked? It’s apparent now why the change, everyone involved made money.
Which brings up another issue the guy who figured out the HFT (high frequency trading ) millisecond in computer code which made millions and nothing has changed there either.
The book you might remember called the Big Short.
Most of the effects will be administrative issues. For most recent financial instruments that reference a LIBOR rate, there is probably some language in the contract or the master agreement between the parties that deals with the possibility that the rate upon which the contract depends will no longer be published, and what to do in that case. For older instruments that don’t contain that language, there will have to be some renegotiation or, that failing, legislative fiat, to determine how to modify them.
One complication is that LIBOR and the like come in a variety of tenors (2W, 3M, 1Y, &c) while SOFR is fundamentally an overnight rate. I’ve seen talk of inferring a tenored version of SOFR by inferring from futures.
This is a very complicated question. The short answer is that new contracts will use some new reference rate. Old contracts may have a fallback provision that specifies how the interest rate will be calculated if the LIBOR rate goes away, so that’s pretty simple. In other cases, parties to a contract governed by LIBOR will have to come to a new agreement. For instance, if your credit card is tied to LIBOR, they will send you amended terms and conditions that say “on this date, instead of LIBOR, your reference rate will be [something new].” If you keep using the card, you have agreed to the new terms.
Some contracts aren’t contracts of adhesion (like a credit card) but are carefully negotiated, like swaps. The parties to the swap will have to modify their agreement to use some new reference rate. At the margins, one new reference rate might benefit one party over another so every party has an opportunity to try to game this to their advantage. On the whole, though, both parties want to continue the swap so they have an incentive to actually decide the new reference rate fairly.
There are a million details and potential points of uncertainty that come about when changing the reference rate. For example, if I renegotiate my old swap to get a new reference rate, is that creating a new swap contract? If so, is that new swap contract subject to rules for new swaps adopted after the Dodd-Frank Act?
The Fed’s Alternative Reference Rates Committee was set up to think about and address issues like this. They are incredibly busy right now.
I’m not sure about which postponement you are talking about. If you could link to an article, I could try to explain it.
This is an entirely different question that really has nothing to do with LIBOR’s retirement. Glass-Steagall was a Depression-era law that separated commercial banks (which took customers’ deposits) from investment banks (which underwrote companies’ stocks and bonds). I’m giving short shrift here but the general idea was that the federal government was going to guarantee depositors’ money to restore depositors’ faith in banks. The government didn’t want the investment banking parts to put depositors’ money at too much risk (often called moral hazard), so they separated investment and commercial banking. Over time, safe commercial banks attracted lots of assets from depositors but were stuck making relatively safe and less profitable investments. Investment banks could make more profitable investments but took more risks. Occasionally, an investment bank would blow up spectacularly but in general, they were more profitable. Since they were so risky though, their cost of capital was higher and they generally didn’t have as much in assets as the commercial banks. In the 1990s, commercial banks wanted to use their big balance sheets to make the kinds of returns that investment banks made, so they lobbied Congress to repeal the Glass-Steagall Act, which Congress did.
It’s not that there was particularly less fraud due to the Glass-Steagall Act, there was just less risk taken by the commercial banks. Other reform legislation from the Depression did fight fraud (like the Securities Act of 1933 and the Securities Exchange Act of 1934, and many others) but these antifraud protections were largely unaffected by the repeal of Glass-Steagall.
It’s not one guy. It’s many. What do you propose should change?