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Thursday, July 5, 2012
'No one's clean-clean'
Lord Acton may have been right and corruption is really a function of power. But the seemingly endless parade of banking scandals in recent months suggests that money is every bit as corrosive.
Last week, the British bank Barclays provided more compelling evidence when it agreed to pay $453 million to U.S. and British authorities to settle allegations that it manipulated key interest rates — and the Barclays settlement is just the tip of the proverbial iceberg of this scandal. Plainly, the system of financial regulations needs reassessment, and with it, fundamental assumptions about the role of financial institutions.
Barclays was charged with manipulating the London interbank offering rate, or Libor, the rate that is used to benchmark 10 major currencies and 15 borrowing periods, and an estimated $360 trillion worth of loans and financial contracts around the world each year.
Libor is determined in a quaint fashion: Every business day since the mid 1980s, more than a dozen banks call the British Bankers Association (BBA) to estimate the rates at which they borrow money from other banks.
The highest and lowest rates are discarded, and the average is reported at 11 a.m. London time. This rate becomes the benchmark for everything from credit card rates to derivatives indexes. A similar system is used for Euribor, a separately managed series of euro-denominated rates.
Barclays conceded that it fudged its estimates, reporting rates that were tailored to its needs on a given day, such as the expiration of trades, to ensure that it booked no losses.
An ample and depressing trail of emails illustrates the regularity of the practice — virtually every day — and the participants' recognition of their manipulation.
During the onset of the financial crisis of 2007-08, emails show that Barclays' Libor submissions were kept artificially low to avoid sending signals to the market that the bank was having trouble accessing funds.
Last week, Barclays settled a civil case by agreeing to pay some $450 million in fines to the U.S. Commodity Futures Trading Commission, the U.S. Department of Justice and the United Kingdom's Financial Services Authority. A criminal investigation in the United States continues.
In a sad commentary on the state of financial behavior, a Barclays executive conceded to a BBA manager four years ago that "We're clean, but we're dirty-clean, rather than clean-clean." The BBA manager responded that "No one's clean-clean."
Other banks implicated in the Libor fixing include Citigroup, HSBC, Royal Bank of Scotland, and UBS. Broader investigations into Libor irregularities are taking place in Japan (where UBS and Citigroup have already been disciplined), Canada and Switzerland, all of which are being facilitated by "cooperating parties" — banks that sought deals with authorities after being caught. Euribor rates are also being investigated.
Also last week, Britain's FSA announced that it settled with four banks — Barclays, RBS, HSBC and Lloyds — that have since 2001 mis-sold financial insurance products designed to protect small businesses against rising interest rates. This is yet another in a two-decades long series of mis-selling cases that is reckoned to cost banks in excess of $14 billion in compensation.
Meanwhile, in the U.S., a group of financiers were convicted of working with almost every major bank and financial institution in the U.S. to rig public bids on municipal bonds. The defendants in the case of the U.S. v. Carollo conspired to lower interest rates on securities for public institutions in "virtually every state, district and territory in the United States," a business estimated to be worth $3.7 trillion.
This follows the avalanche of charges regarding falsifying loan documents, rigging securities to favor certain investors, and the perennial instances of insider trading: Japan knows the latter especially well as recent revelations regarding unsavory practices at Nomura Securities, Daiwa Securities and SMBC Nikko Securities make plain.
Some counter that no damage was done. In the Libor case, high and low bids were thrown out, so rates may not have been rigged. In the Carollo case, agreements were struck that left all parties happy.
Those defenses are disingenuous. Rates were manipulated to very definite ends; the actors saw themselves as benefitting from the outcomes — to a third party's disadvantage. Equally, if not more important, the integrity of the financial system itself has been compromised.
If finance is the lubricant of modern society, then this damage is fundamental.
The scale of these crimes, the length of time they have been perpetrated and the fact that they involve repeat offenders fatally undermines the notion that the financial sector is capable of self-regulation. These institutions are only caught, never chastened.
Moreover, it looks as though the regulatory authorities seem overly deferential to financial institutions by imposing fines that are derisory in relation to the losses engendered, as well reluctant to acknowledge that these are serial offenses.
More distance is needed between regulator and regulated, and more resources devoted to policing the industry.
There is also a need to look hard at whether institutions are too big to fail. This biased assumption too perpetrates a mindset that puts individuals and institutions above the law.
Finally, we have to reconsider our attachment to growth. Some charge that regulating banks more strictly will slow economic growth. They are right, but growth was never fairly distributed and, in some cases was an illusion, a fact made plain after the crash. Slower growth may be a more realistic outcome, but it will prove fairer and ultimately more stable.