Let’s start with some context. The size of the entire U.S. economy is roughly $21 trillion.1 The market capitalization of the largest stock (Apple) in the US is roughly $2.4 trillion, and the total U.S. government debt is roughly $23 trillion.2 All are very large numbers.
Yet there’s another market that is much larger, much more complex, and is one our dear readers have likely heard very little of: London InterBank Offered Rate (LIBOR).
While I recognize the mere mention of the word is enough to make many of us begin longingly thinking about bedtime, I contend that given the size and complexity of the LIBOR market, it is worth understanding.
This index rate is estimated to influence more than $200 trillion of loans, securities and deposits.3 It is massive, it is controversial, and it is going away. That’s right – one of the world’s most important reference rates is going to be replaced in some form or fashion by the end of 2021 (as it stands now), and we don’t yet really know how it going to work.
Yet where chaos and ambiguity reside, opportunities for learnings flourish.
As such, in this update we will attempt to tackle two issues: The latest on the COVID-19 outbreak, as well as a dissection of LIBOR (what it is, why it matters, and what MassMutual is doing about it).
With that, let us begin.
The status of COVID-19
Charts 1 and 2 are my favorite representations of what is happening in the world with respect to COVID-19 because the charts:
- Ignore the headlines
- Zoom out far enough to discern the relevant trends.
- Show both the levels and the growth rates (I continue to argue the growth rates are what matters).
Chart 1: COVID–19 Worldwide Outbreak 4
To orient, the blue lines demonstrate the total number of cases around the world and correspond with the left axis. The grey line demonstrates how the number of cases is growing and corresponds with the right axis.
The summary, thankfully, is that the growth rate of cases continues to slow. Both globally and domestically, the outlook continues to improve, and in dramatic fashion. For the first time since this started, the global number of cases has shrunk on a handful of days.
Case growth rates are falling, and death growth rates are falling. Things are getting better, and markets are reflecting what the data (not the financial press) is showing. This is great news, and while we are clearly not through this crisis (and there are valid reasons to be worried about fall and winter), there is no doubt the numbers are reflecting optimism.
Domestically, the number of cases in the United States is now growing slower than at any time since the outbreak began in March. Back in March, when this was expanding rapidly, the United States was growing at more than 30 percent per day, which is both terrifying and unsustainable. The country implemented social distancing, masks, restrictions, etc., and the growth rates fell to mid-teens in April, down to 2 percent in June, and now, the U.S. COVID-19 cases are growing at less than 0.6 percent per day (on average).5
Chart 2 demonstrates this further by zooming in on the growth rate since the beginning of April.
The blue line (U.S. only) in this chart corresponds with the grey line (global) in Chart 1. The growth rate was very high in early April, then fell very quickly, then rebounded a bit toward the beginning of July (as growth in the South exploded) and is now at all-time lows (roughly 0.89 percent on a five-day smoothed basis). To be clear, this is higher than the global growth rate, but improvement nonetheless.
Chart 3 takes the very same data and converts it to the number of days to double the cases in the United States. This is often a more intuitive and relatable way to understand how growth rates are changing.
The chart largely follows the story of the United States. In late March, the U.S. was in complete lockdown as case growth was largely out of control. At that point, the U.S. was doubling cases every three to five days. We learned, we evolved (and no, not quickly enough), but we nonetheless improved to late May and early June where we were now doubling cases every 64 days.
The South then began to re-open, and many states pushed back entirely on some of the government guidelines. Growth rates increased again, and the days to double fell to 37 days on July 13.
Fortunately, that has now reversed.
The U.S. is now doubling cases in more than 100 days, which is an all-time high (meaning growth is at an all-time low) since the beginning of this pandemic in March. The world is now doubling cases every 200 days and continues to slow. This is tremendous news on many fronts.
The London InterBank Offered Rate
Let me state up front this discussion on LIBOR is a delicate story to tell. If we dive too far into the details, eyes will roll, and the sound of snoring will be heard far and wide from our beloved readership. Yet what makes this delicate is LIBOR itself is a fairly detail-packed subject. As such, let’s try and be methodical by breaking this down into:
- Why we care
- How it works now
- Why this is changing
- What it is changing to
- What are we doing about it
Here are the breakdowns.
LIBOR is the world's most widely used benchmark for short-term rates, but its era of influence is slated to end by December of 2021.
Some $200 trillion to $300 trillion in mortgages, consumer loans, corporate debt, derivatives and other financial instruments reference LIBOR, and its influence as a market barometer is even more wide reaching.
Once the phase out occurs, all dollar-denominated loans, derivatives, and debt will reference a new rate.
Why we care
Many, many different instruments and securities reference LIBOR, and many of them have no legal language that contemplates what to transition to. Examples include student loans, mortgages, credit cards, certain types of bonds, lines of credit, swaps, CDs, CDOs, and on and on and on.
As such, if the rate changes, consumers and businesses have either less money or more money to spend on other items.
How it works now
The concept of LIBOR is fairly straightforward. Banks need to figure out what to charge (individuals, other banks, etc.) for a loan, and so they start with how much it costs them to get the money for that loan.
Every day, a group of pre-selected banks are polled to ask what cost those banks can borrow from each other at. Those banks respond, and with a quick process of “remove the highest, the lowest, and average the rest,” the rate is now set. (Yes, it’s a bit more complicated, but honestly not much.)
Why this is changing
As an astute reader may recognize, the aforementioned process leaves some room for interpretation and potential manipulation. In 2008, a subset of those banks manipulated the LIBOR rate for their own gain. Once discovered, this resulted in billions of dollars of fines and profit disgorgement, and to bring this full circle, the desire to improve upon the process that exists.8
What this is changing to
This is where it gets a tad confusing. The short answer is the answer isn’t yet known. There are dominant possibilities (in the US something called SOFR is leading the race, although Ameribor is making a comeback), but the path has not yet been crystalized. Part of the problem is that the different participants have different needs and borrowing costs, and therefore, support different rates.
The upside is that the change will likely be more objective (and less likely to be manipulated), but the transition itself may be chaotic.
Regardless, the debate is ongoing, and we are watching it closely.
What we are doing about it
At the corporate level, MassMutual has established a cross-functional LIBOR Transition program and is actively focused on the various aspects of the transition.
The summary thus far, is that we do not believe the LIBOR transition will have a material impact on the business of MassMutual nor our policyholders.
We do have several investments that could be impacted, but we are working on various mitigants, and again, we expect the impact to be minimal.
In short, it’s a complicated subject, with a straightforward and yet fragile core. We are watching it closely and will update you again as we get closer to the transition.
Stay safe, stay calm, and please turn off the financial news channels.
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