Alternatives to Libor in Consumer Mortgages

Abstract

Many adjustable rate mortgages in the United States are indexed to Libor. While the accuracy of this rate has recently been called into question, another issue affecting U.S. borrowers has become evident since the onset of the financial crisis. Specifically, many U.S. consumers with Libor-based loans may have been hit with substantially higher payments when their loans reset during the financial crisis than if those loans had been tied to a Treasury rate. We investigate several alternative reference rates for consumer loans and estimate their payment effects on a large sample of Libor-linked U.S. mortgages. We find that these alternatives would have delivered savings over Libor of about $25 to $45 per month and substantially more for mortgages that reset in October 2008.

LIBOR: Origins, Economics, Crisis, Scandal, and Reform

“…The market for U.S. treasuries is likely the most liquid in the world, even under financial duress. Moreover, Treasury constant maturity rates were heavily used as a reference rate for ARMs prior to the popularization of LIBOR, and in fact is still referenced by many ARMs today (Schweitzer and Venkatu 2012). The possibility of replacement using a combination of several rates has also been discussed.…”

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“…SeeMcCauley and Seth (1992), who describe how an asymmetry in the eurodollar reserve requirement's application to US chartered banks versus foreign banks' US branches at times gave foreign banks a funding advantage over US banks in their US lending.11Schweitzer and Venkatu (2009) showed that LIBOR replaced domestic interest rate benchmarks in most prime ARMs and in all subprime ARMs in Ohio in the 2000s.…”