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Will The Financial “Big Bang” Trigger A Derivatives Market Meltdown?


What on Earth is the LIBOR rate? And what is the SOFR rate? If you have asked yourself at least one of these questions, this article is for you.

I'll start by explaining some terminology related to lending so you can have a better understanding of the topic and better prepare. I also demystify the LIBOR rate, the SOFR rate, and connect the dots at the end.

Do you want to know why the central banks want to change the interest rate? Dive right in!

LIBOR Rate Demystified

This big bang that everybody has been talking about is simply moving the universal rate used for lending. From LIBOR over to something called SOFR, which is S-O-F-R. 

That's a rate that they're going to be using, just domestically, but let's go over what LIBOR is so we can really get straight on what these terms are. 

We're going to be transitioning from LIBOR over to this new rate called SOFR, S-O-F-R.

For a definition of LIBOR to figure out exactly what it is and what it does here is Investopedia.

The London Interbank Offered Rate or LIBOR is actually a set of several benchmarks that reflect the average interest rate at which large global banks can borrow from each other. It's the leading indicator used to price loans and other debt instruments.

The key takeaway is this is an interest rate that's derived not from transactions, but just from questioning other banks.

Each morning around 7:00 AM Eastern Time the ICE Benchmark Administration asks a panel of contributor banks to answer the following question. At what rate could you borrow funds where you can do so by asking for and then accepting interbank offers in a reasonable size just prior to 11:00 AM London time?

They quite literally just get a call on the phone, answer the question, and from those questions whatever they say, 20% or negative 10%, they just take their word at face value and they take an average of that, and that's how they get LIBOR. Pretty simple.

There are a total of 35 LIBOR rates posted each day. Interest rates are compiled for loans within seven different maturities (or due dates) for each of the five major currencies, including Swiss franc, euro, pound, sterling, Japanese yen, and the U.S. Dollar.

It's pretty straightforward, but let's go over a visual.

I drew three countries: the USA, 123, and XYZ. Each country has its bank, XYZ, USA Bank, and Bank 123. These are commercial banks and they don't necessarily have to be in all these different countries.

I'm just using this as an example because international banks are involved with different currencies to calculate each LIBOR rate. 

For Bank XYZ, we have the fat cat Bankster Wang, and in the middle, we have fat cat Bankster Bob. And in Europe, we have Bankster Pierre.

Let's say some girl or guy just gets on the phone and says, “Hey Bob, how much do you think you can get money from if you borrowed money from Wang at around 11 o'clock today? Then how much would you lend money to Pierre?” 

And Bob says, “Well, I could probably get it from Wang around 6%. I lend it to Pierre around eight.” They asked Pierre the same question and he's European and most likely French. 

He's very short and disgruntled and just kind of pissed off at all times, especially at those Americans.

But he says, “Well, I'd lend to Bankster Wang at maybe 7%.” Maybe they ask Wang what he might lend to Pierre for, but this interbank lending is just back and forth between the banks.

Then they'd take the average of those interest rates and boom that's LIBOR. In the transactions, we'd have 6%, 8%, 7%, which equals 21%. You divide by three and boom.

Our LIBOR rate for this example would be 7%, but one of the main takeaways that you have to understand is that the LIBOR or rates are unsecured.

When they're asking Bankster Bob, how much he would lend to Bankster Pierre, what the interest rate would be or what he thinks that he could get money from Wang, the interest rate he's referring to is an unsecured rate. 

That means it's without any collateral exchanging hands. 

If Bankster Bob were to give Bankster Wang collateral for the loan, treasuries, or mortgage backed securities, then most likely the interest rate would be a lot lower.

Keep in mind, these interest rates signify a loan that isn't secured with any collateral.

Here is a timeline of the big bang or the transition from LIBOR to SOFR.

You can see, we started in 2020 and their objective is to completely be off the LIBOR system by the end of 2021.

Of course, the big claim here from the central planners and why we need to transition to this new rate is because it's very easy to manipulate the LIBOR rate. 

The banksters could just get on the phone with each other and decide what rate they want to tell the person calling, whichever serves their purpose best and they could just say that rate. It doesn't actually have to be legit.

What's crazy is how many loans are actually derived from this benchmark LIBOR rate. Jeff Snider, my good buddy who does a fabulous podcast with Emil Kalinowski called “Making Sense” has discussed this often.

Jeff would argue, they're making this transition not really because it's manipulated and they want a better system, but more so because the LIBOR rate exposes the fact that the world reserve currency isn't the dollar, it's the euro dollar. 

Think about this, if you're getting a mortgage in the United States, it's most likely going to be based on LIBOR.

That's a rate that's outside of the United States, that's not a rate that's exclusive to the domestic economy in the USA. 

Why is that? Because the majority of the cash in the global economy isn't necessarily dollars, but it's dollars that have been created by a banking system outside of the purview of the Federal Reserve.

I don't want to go down that rabbit hole too far. I've done several articles on that.

But the main takeaway Jeff would say is: “Listen, this is not about a rate that's being manipulated. It's about the Fed saving face.”

It's about the fact that our economy is built on asset prices, debt, and confidence.

They think that if they move the rate from LIBOR to SOFR, they'll be able to maintain confidence, meaning they are important, and that the central bank is actually central to the dollar monetary system when in reality it isn't. 

What type of loans use LIBOR as a benchmark?

I think a better question would be what type of loans do not use LIBOR? We're talking about everything.

Mortgages, car loans, student loans, business loans. And of course everyone's favorite derivatives.

SOFR Rate Demystified

  • What exactly is this interest rate?

  • Where does it come from?

According to Investopedia:

The secured overnight financing rate or SOFR is a benchmark interest rate for dollar-denominated derivatives and loans that is replacing the London Interbank Offered Rate or LIBOR. SOFR is based on transactions in the Treasury repurchase market and is seen as preferable to LIBOR since it is based on data from observable transactions rather than on estimated borrowing rates.

I'm going to throw in a quick bonus for you because the main derivative they use LIBOR for, is something called an interest rate swap.

I've gone over it in previous articles so I won't go over extensively now, but I just wanted to walk you through that briefly. 

Here are Corporation ABC and 123. Corporation ABC has a variable loan, but they want a fixed-rate loan, and vice versa for Corporation 123.

They go to the bank, let's say JP Morgan and they say, “We want an interest rate swap. We hate these variable rates” or this guy says “I hate the fixed rates.”

What they do is they set up this contract where ABC pays 123 a fixed amount of money, and 123 pays ABC a variable amount of money.

They actually don't swap loans, but the net result is their payments actually end up moving from a variable to a fixed-rate or from a fixed rate to a variable.

The bank gets right in the middle of this, so I'm sure they're charging fees. 

I have no idea why they would be incentivized to manipulate LIBOR, but for some reason they can make an additional spread by doing so. 

If you want to learn more about it, I'd suggest going right to the Khan Academy on YouTube. Just type in “interest rate swap”, that'll take you to a couple of really quick videos that'll explain it in very easy to understand terms.

Back to Investopedia…

While SOFR is becoming the benchmark rate for the dollar-denominated derivatives and loans, other countries have sought their own alternative rates, such as SONIA and EONIA.

I think SONIA is for the Brits and EONIA for the European Union, if I'm not mistaken.

The three main takeaways I really want to emphasize are these:

  1. It's crucial you guys understand SOFR is a secured interest rate backed up by an asset, but LIBOR is unsecured. Therefore, SOFR is almost always going to be lower because it's backed up by collateral. It's not unsecured.
  2. SOFR is based on transactions in the repo market. 
  3. Other countries are going to use different ways to measure their benchmark interest rate. In other words, they're going to use a different system in a different infrastructure altogether.

This is an interest rate determined on repo transactions. So, let's go over a quick overview so we understand how they're getting this rate.

Usually what happens in the repo market is the primary dealer banks or other commercial banks, which I call A, B, and C, issue loans to financial institutions and hedge funds that need money for a certain term. They do it for, let's call it one day, three days, or 30 days.

It's usually a contract between the two entities, or, in this case, the banks will go ahead and lend money to the hedge fund or the financial institution and the hedge fund or financial institution will give them collateral, usually treasuries to back up the loan.

Then, after the term, let's say 30 days after, they just go ahead and swap back. 

The hedge fund would give the bank their money back plus some interest and the bank would give the treasuries back to the hedge fund. 

I also want to point out that it's not just a transaction between the banks and the hedge funds or financial institutions. It can be between banks.

Bank A could do a repo with Bank B. Bank B could do a repo with Bank C, but we all know what happened last September 17th, 2019.

That's when the repo rate shot through the roof up to almost 10%. That took all the others interest rates up with it, including Fed funds.

In other words, the Federal Reserve completely lost control of all of the interest rates that really matter, including their own Fed funds rate. 

They had to step in and provide liquidity for the market, which means they bought all these treasuries from the primary dealer banks and the banks under the Fed's umbrella. 

The Fed just gave them bank reserves in return hoping that those banks would take all these reserves, the excess balance sheet capacity.

Now, they can issue more loans theoretically, and go into the repo market to bring this rate down. That was their goal and to give them a little credit here, it actually worked.

The repo rate did come down, but let's remember what's going on here, let's really pay attention. 

What they're doing is the Fed is taking treasuries out of the system. Whenever they do quantitative easing, as you guys know from reading my articles, all it is is an asset swap.

They're just trading treasuries that are on the balance sheets of the banking system. They're trading those treasuries for bank reserves.

Remember, these banks have accounts with the Fed. The treasuries go to the Fed, they go onto the asset side of their balance sheet, and then they give those banks bank reserves that are a liability of the Fed and an asset of the banks.

They give them those bank reserves in return.

It's just that, asset swaps, bank reserves for treasuries, but they're taking treasuries out of the system. Taking treasuries away from banks that could use them in the repo market

I know I'm being a little redundant here, but I need to make sure everyone is on the same page because it's crucial you understand the concept.

let's go over to the next chart of SOFR, the effective Fed funds rate and the Fed funds target range.

You can see on the right it goes from zero basis points up to 500 basis points or 1%, 2%, 3%, 4%, and 5%. It started in 2016, and it goes all the way to the end of 2019 and the beginning of 2020.

This is the SOFR rate, and its tied to repo. So it's not that smooth. It has these periodic spikes, it goes up and down, and then it kind of levels out. It goes up with Fed funds.

Remember how out of control it got in September 17th.

SOFR went up to 500 basis points or 5%. If your mortgage, your car loan, student loan or if derivatives are tied to an interest rate that can go from 1% up to 10% in a day, what would that do to the entire market?

  • What would that do to the debt market?

  • You're starting to connect the dots here? 

Let's not forget during the Coronavirus in March, when the Fed took their rate all the way down to zero, what did they do in the repo market? 

They committed to doing a trillion dollars a day. $1 trillion a day in the repo market.

Now they didn't actually do that many transactions, but they committed to doing that many transactions. 

What was the rationale that they give us for moving from LIBOR over to SOFR?

Oh, we can't use LIBOR anymore, it's manipulated. 

Well, how manipulated is the repo rate when the Fed is coming in and committing to a trillion dollars a day?

It's the most manipulated rate imaginable.

The central planners are trying to brainwash you into believing they're moving from one rate to another because the first-rate was manipulated when the rate they're moving to is even more manipulated. 

I think that once you start putting the pieces of the puzzle together, their game plan becomes crystal clear.

Connect The Dots 

It's time to connect the dots and go over some potentially catastrophic unintended consequences. Let's start with this main chart from 2018 to 2020, this is LIBOR and SOFR.

On the left, it goes from 0% to 5%. The blue line is SOFR, and again, that's going to mimic the repo chart that we went over earlier in the article. 

The red line is LIBOR, and the first thing that you can notice is the LIBOR rate is very smooth. That's what the banksters are telling the guy on the phone that they'd be willing to lend to. 

They're not real transactions, it's just some guy's opinion that could be made up or not, who knows. Of course, going to the repo market, it doesn't go up at all.

Sure, the actual transactions are over 500 basis points, over 5%, but the guy on the phone is like, “Oh yeah, that bank, no problem. I'd lend them to 2% easy.”

It's trying to get the benchmark interest rate for every single debt instrument on the planet from Donald Trump's Twitter feed. He's going to tell you whatever you want to hear.

The LIBOR rate on this chart is a heck of a lot smoother, maybe because it's manipulated, and it's not a real rate based on transactions. 

Why would it benefit the Fed and the central planners to have that rate a lot smoother? 

It goes back to what we were talking about with confidence. The entire economy is built on asset bubbles and increasing amounts of debt and confidence. 

If the general public and the markets lose confidence in the Fed's ability to manage the system, the whole house of cards comes crashing down

Check out another chart, and this is of the TED Spread. 

This is the three-month library rate minus the three month interest rate for T-bills. This has been a great indicator in the past that the Fed is supposed to manage big problems.

 It spiked up here dramatically and I smoothed out this chart.

You can see that it's really volatile going up and down, but it really spikes in 1987, that was the huge stock market crash, black Monday.

Then it spikes again around the GFC because that was a crisis that revolved around the banking system. Remember in 2021, they're going to completely abolish LIBOR. 

If there is no LIBOR, there's no TED Spread, and if there's no TED Spread, well, that's another indicator that we have to determine the health of the banking system. 

The Fed is taking away all of this data, sweeping it under the rug, and pretending that it doesn't exist. “Nothing to see here. Let's just forget about that pesky TED Spread, we don't need to worry about that anymore.” 

It goes back to their needing to instill confidence in the overall market. But let's think this through even further.

Remember the timeline we discussed? Everything starts in 2020, the big bang transition from LIBOR to SOFR.

If I'm the Fed, I'm thinking, “Okay, starting in 2020, now that we're trying to transition into this SOFR rate, I better pay attention to it and better make sure it's super, super smooth.”

Well, in order to get SOFR super smooth, what do they need to do? They need to make sure the repo market is super, super smooth. 

Of course, when we had problems during the coronavirus, so the Fed is going to come in guns blazing, and just go completely over the top committing to $1 trillion a day.

Did they do that to bail out the repo market?

Or did they do that to make sure that the SOFR rate remained smooth?

I think there's more to it than the Fed trying to eliminate the TED Spread or the indicators that show problems in the banking system.

Trying to smooth out the repo market, and therefore, SOFR to make sure that the confidence the general public of the market has in the Fed is remaining at very high levels.

I think there's more to it than that because let's also notice that the SOFR rate, the blue line is almost always under the LIBOR rate, the red line.

That would make sense because although the LIBOR rate was just Trump's fake news, whatever he wanted to say, it was based on an unsecured loan, so no collateral involved.

It's basically like you taking out a mortgage or a home loan and not writing a personal guarantee on it or not using the home itself as collateral.

Just imagine getting a loan from a bank, what the interest rate would be if there was no collateral involved whatsoever.

Since SOFR is a secured rate, in other words, collateralized, usually with treasuries, it's most likely going to be a lot lower than LIBOR. 

Why would they want lower interest rates? I think you could probably tell just when I said that out loud, they need more and more debt. 

In their minds, they want to try to promote people to go out there, buy, borrow, and spend. The lower they can get interest rates, again, this is their words not mine, the better they think it is for the overall economy.

If interest rates of almost everything, mortgages, car loans, student loans, business loans, and derivatives are tied to a benchmark rate…

Why not have a benchmark rate that's a lot lower than the previous one?

It allows the Fed and the central banks to drop interest rates in the real economy even further.

Those are some of the intended consequences…

What are some of the potential unintended consequences? 

Remember I mentioned this could completely change the infrastructure for how new dollar-denominated debt is created. 

What makes a global reserve currency, the global reserve currency?

It's not that it's just a piece of paper with green ink, it has nothing to do with it. 

The whole reason the United States dollar continues to be the global reserve currency and why it's so hard to dethrone it, is because of the infrastructure that's built around the dollar itself, inside and outside the United States. 

I'm not saying that the dollar isn't going to be the reserve currency anymore. 

What I am saying is the infrastructure around the dollar being the reserve currency is starting to crumble and this is a perfect example of that.

Because in the United States, we're moving from a global benchmark to a domestic benchmark. They're doing the exact same thing in Britain and in Europe. It's becoming much more fragmented. 

This is just one step closer to the dollar losing reserve currency status. I think the Fed and the central planners could have made an even bigger fatal flaw.

In their minds, they think they can control this SOFR rate, they thought they could control the repo rate and the Fed funds rate, but we found out last September, that's not true at all. 

So, although they've been trying to control it to a greater degree in 2020, what we saw with those charts, barely even going up or down, it doesn't mean that they can't lose control of it in the future.

If the benchmark rate for all derivatives contracts does spike up to five basis points, or even up to 10% as it did before, the entire market would implode.

Just think about that, there's a quadrillion dollars worth of derivatives.

Here is the size of all the stock markets in the world combined, now show them the size of the entire derivatives market. 

It is unbelievably huge. 

It's an elephant standing on a peanut shell and the Fed and the central planners have replaced a nice, smooth peanut shell with one that can spike up to 5% or even 10% bringing down the entire system.

I'm sure right now your friend and family member Fred is saying, “George, you have to take off that tinfoil hat, you and those Austrians and all those people that watch your YouTube channel are just fear-mongering, you don't know what you're talking about.” 

Okay, fair enough point, what would my rebuttal be to that? I would say, friend and family member Fred, let's go back to what Jeff Snyder has been teaching us over the past few years and that's that the central banks are not central.

What does he mean by that?

Let's take the Fed as an example, in our minds, the Fed is the center of the monetary system domestically.

It's also the center of the dollar monetary system globally, but in reality, that's not the way it works.

In reality, the Fed is only the center of a little piece of the pie of the dollar monetary system, because the Euro-dollar market is really the market that calls the shots

They operate in the shadows outside of the control of the Fed. This is what Jeff Snyder always talks about. 

That they're not in control of the system, they're not central, they're just part of a little piece when we have to focus on everything else that they can't control. 

Again, going back to SOFR and understanding that if they did lose control, moving forward to the repo market, it would be absolutely catastrophic. 

Let me be clear, I'm not saying that this is definitely going to happen, there are no certainties, there are only probabilities.

What I am saying is the probability of a catastrophic event moving from LIBOR to SOFR is higher because the market doesn't realize that the Fed or the central bank isn't central to the US dollar monetary system. 

They're only a small piece of the puzzle.

If they only control, let's say 25% of it, we should be far more worried about the other 75% of it that doesn't care about the US economy at all and could spike the rates up to the moon at a moment's notice, just like they did September 17th, 2019. 

When I'm talking about “they”, I'm talking about the banks that operate outside of the Fed's control, the offshore banks that operate in the shadows.

The shadow banking system that creates additional dollar-denominated loans, therefore additional dollars.

Yet, we haven't even begun to connect all the dots, so let's dive down this rabbit hole and if you haven't poured yourself a good stiff drink, now's the time to do so, so sit down and buckle up.

The repo market works by the banks lending money to the hedge funds in the financial institutions for a specific term and those loans are backed by collateral, that would be treasuries. 

If there are no treasuries, there is no repo market, but let's remember what quantitative easing is. That's when the Fed is buying treasuries from the marketplace and replacing them with bank reserves. 

If the Fed does QE, one, two, three, four, or infinity, that's pulling collateral out of the repo market, got it? But SOFR equals the repo market, because the SOFR rate is derived from the repo rate.

But the repo market is tied to pristine collateral, on the run treasuries. If the Fed is buying more of those treasuries, that means less collateral in the system to make it function properly. 

Let's take it to an extreme, and if there were no treasuries in the repo market, it would collapse. The amount of collateral in the system is tied to the amount of quantitative easing the Fed does.

The more quantitative easing the Fed does, the closer it takes us to repo market failure. 

They call them repo fails, where the transactions don't go through, or the closer it takes us to one of those giant repo spikes, meaning the repo market imploding. 

If the repo market implodes, then SOFR interest rate skyrockets, and if SOFR skyrockets, the derivatives market implodes. And if the derivative market implodes, the entire global economy comes crashing down. 

You may be saying to yourself, “I get it. But there has to be a solution.” Well, there is. The solution would be for the government, your drunk, insolvent uncle Sam, to create more treasuries.” 

How do they create more treasuries?

By spending more money into the economy, but if they do that, naturally interest rates would want to go up because who in their right mind would want a claim on future dollars, whether it's 10 years down the line, or 30 years down the line at a 1% interest rate?

If inflation expectations are increasing by your drunk insolvent uncle Sam having to spend not only like a drunken sailor but an entire pirate ship of drunken sailors. 

  • Is that it, is that the solution?

  • All we have to do is have the government spend more money, create more treasuries, which gives the repo market, the collateral it needs?

Not so fast, because remember sovereign, corporate and consumer debt is at all time highs.

We can't afford to have interest rates go up at all, or it does the exact same thing as the derivatives markets imploding.

It implodes the whole system regardless of how many derivatives or quadrillions worth of derivatives are actually out in the system. 

So, how would the Fed prevent interest rates from going up?

They peg the yield curve. How do they peg the yield curve? By doing more quantitative easing and taking collateral out of the system and out of the repo market. 

This is the ultimate doom vortex feedback loop and the Fed could have just triggered it without even knowing.

It's all about unintended consequences.