Still, a few “minor” issues remain unsolved with the secured lending standard. The major problem is it hides systemic risk.
During the COVID crash, LIBOR skyrocketed above the Fed Funds rate, echoing stress in the unsecured debt markets. SOFR, meanwhile, failed to show the ensuing turmoil. If a similar scenario arises, monetary leaders must harness the power of other innovations, like Bloomberg’s BSBY index. This index almost perfectly tracked LIBOR during the COVID-19 market panic, allowing leaders to observe financial turmoil, unlike SOFR.
Moreover, $74 trillion of LIBOR loans are estimated to mature after June 30, 2023, when LIBOR is officially repealed. Fallbacks have been implemented but have yet to be stress-tested. Still, there’s no turning back now from the LIBOR transition. We’re stepping into the unknown.
As for the SOFR standard itself, it’s not free of hazards. The prominent risk lies deep in the weeds of the monetary system, with so-called collateral shortages. These are systemic failures of the daisy chains formed in repo markets, which tend to occur during panics.
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