LIBOR’s Death Was LI-Boring

LIBOR is no more. Yes, the London Interbank Offered Rate—which won the dubious distinction of being the alleged destroyer of finance not long ago—faded into oblivion officially on Monday, to basically no fanfare. That people barely even remembered it on the day of its death is a testament to how markets work.

LIBOR, as its name indicates, purported to be the average rate at which banks lent to one another. Every day, banks would report the rates they charged for a range of short-term loans to their peers, and the Intercontinental Exchange (ICE) would compute the trimmed-mean average (which clips outliers) for each maturity. The resulting rates, published daily just before noon in London, underpinned the vast majority of financial contracts. Derivatives, CDs, loans—so, so many were priced at LIBOR + x. Hundreds of trillions of dollars’ worth a short decade or so ago.

The reporting was all done on the honor system, but as it turned out, some of the participants weren’t so honorable. In 2012, it came to light that several institutions weren’t reporting the actual rate they charged, but a rate that would be profitable if it were the actual rate. This was called the LIBOR fixing scandal, and it was a big deal. How could hundreds of trillions of dollars’ worth of financial contracts be based on a manipulated rate? How could anyone have any confidence in the system? LIBOR had to go, the powers that be decided, and be replaced with a reliable rate based on actual market data.

Simple, but not quite, because of LIBOR’s scale and ubiquity. It is one thing to devise a new, more transparent rate methodology. It is another to replace the reference rate for hundreds of trillions of dollars’ worth of derivatives and loans. There was a lot of chatter about the risk of a disorderly transition being a systemic risk. Not that most people saying this knew the ins and outs of the system or could articulate why replacing LIBOR could cause a meltdown, but its size and the system’s complexity seemed fertile enough ground.

But in the end, it turned out to be a big load of boring nothingness. Regulators took their time devising a replacement, which turned out to be the New York Fed’s Secured Overnight Financing Rate (SOFR). The transition was gradual, phased in over many years, as LIBOR-based contracts expired. To help bridge the gap, ICE published “synthetic LIBOR,” a plastic LIBOR that lived on after actual LIBOR went away. There was no chaos, no meltdown, no implosion. Actually, there were few—if any—visible market impacts. As it all unfolded, with its jargon and inside-baseball technical explanations, the world moved on. People outside the industry mostly forgot LIBOR. And when synthetic LIBOR finally published for the last time Monday, capping this sordid saga, it rated 204 words on The Wall Street Journal’s live blog. Which probably inspired an oh yah that from the readers who were able to find it and bothered to click.

This is actually how these things usually go. A thing happens in the financial world, and regulators determine some big change must be made. Industry participants agree, but there is talk that it won’t go smoothly. Investors front-load fear. But then the change happens in painstaking fashion, largely because regulators are trying to mitigate the unintended consequences everyone fears. When chaos doesn’t ensue, people move on, and the change plays out in the background. Far from being some monumental market-moving thing, it becomes part of the furniture. We saw this a while back with the reduction in stock trading settlement times. Now we are seeing the end of it with LIBOR.

Remember this the next time regulators or the industry decides a change to financial markets’ plumbing is necessary. As big as it sounds, and as many teething problems as it might have, markets are really, really, really good at dealing with these things and moving on.