In the years leading up to the subprime crisis, one opaque and easily manipulable index, LIBOR, came to dominate adjustable rate home mortgage loan contracts. In the wake of the crisis, we learned that large international banks had conspired to set the LIBOR rate in order to conceal weaknesses in the financial system and to boost their bottom line. This banking cartel, at times, illegally increased LIBOR to maximize the value of their derivatives bets and other financial positions.1 For years, the interest rate that underpins hundreds of trillions of dollars of financial contracts, including the exploding adjustable rate mortgages, was a lie. Many large financial institutions would later plead guilty to criminal price-fixing.
Approximately $1.4 trillion of consumer loans—loans to individual human beings, to buy a home or finance their education—are currently tied to LIBOR.2 Families and homeowners, students seeking higher education, and other borrowers all paid too much when LIBOR was falsely inflated. Structural flaws in the financial system stoked collusion and rent-seeking over fair competition.
In issuing today’s rule, the CFPB is playing its part to move the financial system away from this opaque and too easily manipulated index. No new financial contracts may reference LIBOR as the relevant index after the end of 2021.3 Starting in June 2023, LIBOR can no longer be used for existing financial contracts. The final rule issued today helps set the guardrails for an orderly transition away from the LIBOR index. In most circumstances, lenders will replace the LIBOR index with new indices based on the SOFR (Secured Overnight Financing Rate) or the prime rate SOFR is a robust reference rate that is based on actual transactions data and is not vulnerable to the type of abuse displayed in the LIBOR scandal. The prime rate has long been used as an index in consumer contracts.
Creditors and servicers must continue preparing for the end of LIBOR. By developing orderly and clear steps to reduce risks to people who may be impacted by the transition, creditors and their servicers can mitigate compliance, legal, financial, and operational risks and support a healthy recovery.