As the London Interbank Offered Rate nears retirement, quotes for a preferred replacement index for many of the loans and credit instruments that rely on it are now being published.
Before the subprime mortgage meltdown of 2007, home lenders often placed subprime borrowers in adjustable-rate mortgages — many that were indexed to LIBOR.
Such ARMs enabled consumers who otherwise might not qualify for a mortgage to finance a home purchase at rates that were lower than nonprime fixed rates — which could be several hundred basis points higher than prime rates.
While the LIBOR rates could eventually escalate to unaffordable levels, borrowers were advised to make their payments on time and refinance into a prime mortgage two years later.
In many cases, they were able to refinance thanks to lax lending standards at the time.
Lenders were safeguarded against these loss-leaders by requiring prepayment penalties that insured they’d be made whole if borrowers paid off the loans before the rates increased and the loans became profitable.
The American Bankers Association reported late last year that more than $160 trillion in outstanding loans, derivatives and financial products are pegged to LIBOR.
But after the crisis,
regulators took steps to eliminate the use of such high-rate loans and prepayment penalties.
In addition, it was discovered that British bankers who were being surveyed for the index were manipulating LIBOR for their own benefit.
In 2012, the British Bankers Association abandoned its administration of LIBOR, and the index will be retired in 2021.
On
Monday, the Federal Reserve Bank of New York began publishing quotes for LIBOR’s replacement: Secured Overnight Financing Rates.
A report late last year from the New York Fed indicated that
SOFR is the preferred alternative to LIBOR and “is intended to provide market participants with greater transparency into an important segment of U.S. financial markets.” While LIBOR submissions are still based on expert judgment, SOFR is fully transaction based
In addition, SOFR,
encompasses a robust underlying market, is a nearly risk-free reference rate that correlates closely with other money market rates and covers multiple repo market segments allowing for future market evolution.
Bank of New York Mellon and the Depository Trust and Clearing Corp. will provide transaction-level data for three repo market segments.
The rate will be published each morning around 8:30 a.m. based on the prior day’s trading activity.
As of Monday, SOFR
was reported at 1.80 percent. The six-month LIBOR was quoted at 2.45 percent as of last Wednesday.
