This Is What Happened To LIBOR During The COVID Crisis

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

So Joe, I know I said our LIBOR series was at an end, but as we discussed in the previous episode, I lied, and I sort of lied twice because we have two extra episodes, and this is the second one, although I promise this is actually the last one.

Joe Weisenthal (0:34)

Who knows, maybe this won't be the last one.

Tracy Alloway (0:36)

What can I say? LIBOR gets people fired up, and everyone really wants to talk about it. But I will say some of the episodes that were early in our series, we actually recorded those before we had the big March sell-off and all the volatility that we saw in the market. So I think we should actually have another discussion about what we've seen this year with the coronavirus crisis and what it might mean for the LIBOR transition.

Joe Weisenthal (1:06)

Yeah, no, I agree.

I do think it's good to talk big picture and the long-term trajectory of what's coming for LIBOR and the replacement. But in the meantime, LIBOR still exists. And so talking about how this benchmark, what's happened with it during these extraordinary several weeks and months for the market is a useful thing as well, I hope.

Tracy Alloway (1:31)

Yeah. And I guess the big tension that emerges is, should we be attempting to do this big redesign of the financial system, basically redesigning the reference rate to which trillions of dollars of assets are tied at a time when we're distracted by so much else going on in finance, right? We're in the middle of a financial or maybe not financial, but an economic crisis. The Federal Reserve is rolling out all these new programs. Regulators are looking at financial stability, things like that.

Should we be tackling LIBOR at this exact moment? So we're going to explore that tension in this discussion.

Joe Weisenthal (2:09)

And we have a guest today who is a fan favorite for sure. People have had him on before and he had been requested a lot. And then even again, I've got requests like, oh, you should talk to him again. So everything is aligning for this episode or the culmination of the series.

Tracy Alloway (2:27)

The interest rate stars have aligned for us. All right. Well, without further ado, let's bring on Josh Younger, head of US interest rate derivative strategy over at JPMorgan.

And as you mentioned, Joe, a previous Odd Lots guest who talked a lot about some of the turmoil that we saw in the treasury market in March. Josh, it's great to have you back on.

Josh Younger (2:48)

Yeah, it's great to be back.

Tracy Alloway (2:52)

So maybe just to begin with, you could give us a summary of what happened to LIBOR in March when we had the market volatility and not just market volatility, but we did start to see the beginnings of some concerns about the banking system, and that sort of reflected in the interbank lending rate. So what did we see?

Josh Younger (3:13)

So I think it's best to go back to 2008, and that was an environment where LIBOR was this really important kind of canary in the coal mine for bank funding stress and ultimately the stability of financial institutions. So when LIBOR started to move and other short-term rates like Fed policy expectations did not, and that spread, that difference widened out, it ended up being a really important forward-looking indicator for the problems that were going to come and ultimately led to bailouts and a couple of near or actual bankruptcies. And all of the problems that the financial system was facing were kind of presaged by moves in LIBOR. So that's been something people have watched for a while, and there have been episodes over the past 12 years where LIBOR was once again in the spotlight. And the best example of that was the European sovereign funding stress episodes of 2011 and 2012 When initially Greece and ultimately Italy and Spain were coming under stress, their banks were either directly or implicitly part of the LIBOR panel. And we can talk about that as well. But the banks in Europe were all interconnected to some extent, and problems in Italy and Italian banks were ultimately problems for German and French banks. And that went into the LIBOR fixing and LIBOR OIS, OIS being Fed funds, you know, Fed policy expectations, the difference between those two rates widened out quite a bit.

So that was ultimately like something people watched as this financial stability, financial conditions indicator.