Odd Lots This Is What Happened To LIBOR During The COVID Crisis
Jun 5, 2020
In this discussion, Josh Younger, a managing director at JPMorgan with expertise in interest rate derivatives, dives deep into the tumultuous journey of LIBOR during the COVID crisis. He explores the challenges of transitioning from LIBOR to SOFR amidst market volatility and the implications for financial stability. Younger highlights the risks of 'zombie LIBOR' and emphasizes the complexities of using LIBOR for adjustable-rate mortgages. With insights on regulatory pressures and the critical role of fallback provisions, he provides a comprehensive look at the future of financial benchmarks.
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LIBOR as a Canary in the Coal Mine
- LIBOR's widening spread against OIS in March 2020 was the largest since 2008, raising concerns about bank stability.
- This spread has historically been a leading indicator of financial system stress, as seen in 2008 and the European sovereign debt crisis.
Drivers of LIBOR's March 2020 Rise
- LIBOR's rise in March 2020 primarily reflected overall dollar funding scarcity, not necessarily bank credit issues.
- The lack of interbank lending forces banks to infer LIBOR rates based on limited commercial paper market data or other indirect sources.
LIBOR's Suitability as a Benchmark
- LIBOR's sensitivity to funding market conditions raises concerns about its suitability as a benchmark for loans tied to individual and corporate borrowers.
- Its volatility may not accurately reflect credit markets, potentially creating instability.