SOFR Replaces LIBOR

But those with medium-term memories will remember that a scandal erupted around LIBOR in 2010. But you may not know that as a result, LIBOR is probably going to disappear in the next few years to be replaced by SOFR. Since several hundred trillion dollars of financial contracts will be different as a result, it's useful to have at least some sense of what the change means

Jessie Romero tells the story in "Leaving LIBOR: The Fed has developed a new reference rate to replace the troubled LIBOR. Will banks make the switch?" which appears in Econ Focus from the Federal Reserve Bank of Richmond (Third Quarter 2018).

 LIBOR stands for the London Interbank Offered Rate. It's a benchmark interest rate, which means that when LIBOR goes up or down, the payments owed in a few hundred trillion dollars of contracts go up or down, too. The problem is that LIBOR has been calculated as a survey response to a hypothetical question. Romero explains:
 

LIBOR is based on how much banks pay to borrow from one another. Each day, a panel of 20 international banks responds to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 a.m.?" The highest and lowest responses are excluded, and the remaining responses are averaged. Not every bank responds for every currency; 11 banks report for the franc, while 16 banks report for the dollar and the pound. For each of the five currencies, LIBOR is published for seven different maturities, ranging from overnight to 12 months. In total, 35 rates are published every applicable London business day.
About 95 percent of the outstanding contracts based on LIBOR are for derivatives. (See chart below.) It's also used as a reference for other securities and for variable rate loans, such as private student loans and adjustable-rate mortgages (ARMs). In 2012, the Cleveland Fed calculated that about 80 percent of subprime ARMs were indexed to LIBOR, as well as about 45 percent of prime ARMs. Prior to the financial crisis, essentially all subprime ARMs were linked to LIBOR.
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Gary Anderson 9 months ago Contributor's comment

Doesn't Libor measure stress in the system? I read concerns that SOFU will not perform that function.