Bye Bye LIBOR (And Friends)

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Yes, many readers may have heard whispers (or stage whispers) about the demise of LIBOR. Well, it goes on life support on December 31, 2021 and that might also be the date of its death. That’s when the banks that provide its underlying data will no longer be obligated to do so. Who cares? Those who set borrowing interest rates certainly do. Those who have loan documents based on some spread over a LIBOR rate where those documents didn’t consider a back-up rate if LIBOR ever went away care even more.

What is LIBOR? Well, it’s an acronym for the London Interbank Offered Rate. LIBOR is actually an abbreviation (as if one were needed) for ICE LIBOR (Intercontinental LIBOR). It is published for five currencies and seven maturities (overnight, 1 day, 1 week, 1 month, 2 months, 3 months, 6 months, and 12 months). It is based on the answer given every day by a set of large London-based banks (18 in number for the U.S. Dollar version) to the following questions: “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am?” The highest (typically) four of the responses are tossed out, as are the lowest (typically) four. The middle ones are averaged.

[The following is not a political commentary! No flaming!] In 2012, collusion and fraud was observed in the “answers” given by the reporting banks. Basically, some banks were answering the question presented with rates that would serve to increase their profits. This disturbed those relying on LIBOR as an index rate. [Disturbed is an understatement; some banks paid dearly.] The parties relying on LIBOR as an index thought LIBOR was free market driven. They discovered otherwise. It was a scandal. It was estimated that for derivatives alone, 350 trillion dollars’ worth relied on LIBOR. That’s “trillion,” 350 followed by 12 zeros.

Changes were made. Regulation was interposed. But, let’s jump to July of 2017 when the United Kingdom regulatory authority announced that, as of January 1, 2022, it would no longer compel banks to report their interest rate number.

LIBOR may continue in some other form, but it won’t be the LIBOR engraved into today’s loan documents. Earlier this year, the Board of the Federal Reserve joined by the Federal Reserve Bank of New York began to publish an alternate index, the Secured Overnight Financing Rate (surprise: the SOFR). Other serious, recognized groups have also proposed or are working on alternative indices.

Now, we don’t know how quickly LIBOR became an index used in U.S. loans after its first publication at the start of 1986. We also don’t know what those who began to lend based on LIBOR rates thought about its permanency – would there always be a LIBOR? We do know that many of their loan documents ignore the possibility that LIBOR might not exist. Most of those that did envision this possibility give the lender the unilateral right to choose a replacement index. A small number address the disappearance of LIBOR with an “agree to agree” replacement.

This isn’t an issue unique to LIBOR. In 1977, 25- year Treasury Bonds were discontinued. In 1986, 20- year Treasury Bonds were discontinued. Late in 2001, the U.S. Treasury announced discontinuance of 30-year bonds—both nominal and inflation-adjusted. The 30- year bond reappeared in 2006. In 2017, it was rumored that 20- year bonds would come back. There was no one year Treasury Note between 2001 and 2008.

Though its history is complicated (to say the least), the Consumer Price Index began at the time of World War I, about 100 years ago. Its calculation method has changed many times. As buying habits change, the “market basket” used to calculate price changes (the basis for the index) also changes. Following each decennial census, geographic CPI indices are redefined. Currently, almost all CPI “numbers” use a base year of 1982-84. So, before that average could be determined, other base years were employed. The one before “1982-84 = 100” was “1957-59 = 100.” Thankfully, the Bureau of Labor Statistics provided a conversion factor. But, what will happen if the CPI is discontinued or, more likely, the particular CPI used in a document is discontinued? What if, for political or economic reasons, the CPI formula is changed? [Research “chained” CPI on your own.]

How about the “Porters Wage Formula,” an index-like way to adjust New York City operating costs based on wages paid to building porters under their union contract? Will that information always be available?

There is a five-piece metalcore band from Germany – the Caliban Band. In 2006, they released a song: “Nothing is Forever.” Here is part of its lyrics.

Certainty of emptiness, trustful

New pain and thoughts of the path

There is just one constant: Nothing is forever!

Time of calm and peace

Time to look inside

Relic pictures of past

Black and white deceives

Uncovers the glance for my grief

Nothing is forever!

Yes, nothing is forever!

Now, back to the lyrics of the documents we write. They should always recognize that nothing is forever. Wherever we use an index or reference to an external source, we need to provide for a replacement should our index disappear or be radically changed. If we chose an index or external source so that it would be independent of a party’s judgement, then the replacement should be faithful to that concept. It shouldn’t be something that one party chooses. If it is supposed to be market based or independently determined, then the replacement(s) should be similarly determined.

How about “as agreed by the parties”? To Ruminations, that’s just kicking the can down the road. Speaking of kicking the can, here’s a verse from the 2000 release of that name by Bus Stop, a now defunct British dance act:

Kick it, kick it!

Kick the can, man!

Here we go, here we go, here we go!

Kick it!

C’mon and kick the can, man!

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