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Can the Fed’s New SOFR Rate Replace Notoriously Manipulated LIBOR?

Wolf Street  ( Original )
APR 4, 2018

The LIBOR rate was so easy to rig, when traders were finally caught doing so, the quotes from transcripts of their chat room conversations were both appalling in their brazenness and dismaying in how nonchalant they were about breaking the law on a daily basis.

Bragging about how “'If you ain’t cheating, you ain’t trying” was peppered throughout yawn-inducing ‘commiting felonies is business as usual’ commentary such as "I'll coordinate the overnight in the same way as we did last week."

We’ll see how successful SOFR is at replacing LIBOR, but one thing is clear: To be a better alternative, the bar is about as low as it can get.

The LIBOR (London Interbank Offered Rate) was essentially designed to be conveniently rigged for the profit of those rigging it. And so it was widely rigged, as we found out during the “LIBOR Scandal,” in which some of the biggest and most notorious banks had gotten tangled up. Some criminal charges were brought against low-level traders, and some fat fines were levied against the banks.

But the big thing that came out of the scandal was the realization: LIBOR, crucial to the credit-based economy and to hundreds of trillions of dollars in derivatives, had to go.

LIBOR is an average interest rate based on submissions by major banks of what they expect to pay if they borrowed from other banks across the world. There are different LIBORs for different currencies and durations. LIBOR is not based on actual transactions between banks, but on their opinions of what it would cost to borrow from each other. Hence the invitation to rig.

But LIBOR isn’t easy to replace all in one fell swoop. In the US, the Alternative Reference Rate Committee (ARRC), which was put in charge of finding a replacement for the dollar LIBOR, said in March that dollar LIBOR underpins $200 trillion in derivatives and loans. This was 25% more than previous estimates. Derivatives account for about 95% of the $200 trillion.

ORIGINAL SOURCE: The Dollar LIBOR Replacement Rate Has Arrived: 1.80% by Wolf Richter at Wolf Street on 4/3/18