The Baseline Scenario
By Simon Johnson
In the aftermath of the Barclays rate-fixing scandal, the most surprising reaction has been from people in the financial sector who fully understand the awfulness of what has happened. Rather than seeing this as an issue of law and order, some well-informed people have been drawn toward arguments that excuse or justify the behavior of the Barclays employees.
This is a big mistake, in terms of both the economics at stake and the likely political impact.
The behavior at Barclays has all the hallmarks of fraud, pure and simple – intentional deception for personal gain, causing significant damage to others.
The Commodity Futures Trading Commission nailed the detailed mechanics of this deception in plain English in its "Order Instituting Proceedings" (which is also a settlement and series of admissions by Barclays). Most of the compelling quotes from traders involved this scandal come from the Order, but too few commentators seem to have read the full document. Please look at it now, if you have not done so already.
Barclays has acknowledged that its staff took part in a wide-ranging conspiracy (or perhaps a set of conspiracies) to rig markets – including, but not limited to, any securities for which the price is linked to a particular set of short-term interest rates. The collective term for these rates is the London InterBank Offered Rate, known as Libor, but the use of this nomenclature sometimes hides the fact that there is currently a separate Libor daily for each of 10 currencies at 15 maturities, from overnight to 12 months, according to the British Bankers Association. The notional size of the derivatives involved is on the order of $360 trillion.
Barclays could not have manipulated those rates by themselves – and that is not what the C.F.T.C. found or the basis of the Barclays settlement. Rather, some Barclays employees colluded with people at other banks in a way that, over a period of years, moved Libor rates up and down – depending on what would favor the trading positions of the people and organizations involved.
Each Libor "panel" of banks involves 7 to 18 banks. Participating banks submit the rate at which they can supposedly borrow at a particular maturity and in a specified currency, and an average is calculated (taking out high and low values). No one bank is likely to be able to move the calculated Libor rates by itself.
Once the global financial crisis began to bite, there appears to have been a more systematic manipulation of Libor reporting by Barclays management in a particular direction – downward, to make it seem that the bank was healthier and therefore able to borrow from other banks at a cheaper rate.
George Osborne, Britain's Chancellor of the Exchequer (the equivalent position to the Secretary of the Treasury) and a Conservative Party member, said recently, "Fraud is a crime in ordinary business; why shouldn't it be so in banking?" The answer, of course, is that fraud is not allowed in any well-run country.
Anyone who takes personal responsibility seriously should want all those involved to be held accountable – to the full extent of the law in all jurisdictions. Anything that lets individuals escape consequences will further undermine the legitimacy that underpins all markets. Bankers should be leading the charge to clean up their industry.
Nevertheless, five arguments put forward in the last 10 days, singly or collectively, attempt to provide some sort of cover for what happened at Barclays. None of these arguments have any merit.
First, it is argued that this kind of cheating around Libor has been going on for a long time. This may be true, but it is a sad and lame excuse that is unlikely to get anyone off. The bigger question must be: Is the financial sector crooked at its core? Statements about a pattern of behavior only strengthen the case that incentives, culture and organizations are all badly broken at the heart of the world's financial system.
Second, it is also asserted that "everyone does it." This is not any kind of defense – try it next time you are accused of fraud. But the perception that many people could be involved is part of the reason why this scandal has legs. A broad range of involvement across the financial sector is consistent with what is in the C.F.T.C. Order – although the full scope of the conspiracies has not yet been made clear.
There are three United States banks involved in Libor panels: JPMorgan Chase, Bank of America and Citigroup. Are they also implicated in some aspect of rigging interest rates and therefore securities prices?
Barclays was the first to settle with the C.F.T.C., presumably enabling investigators to gain better access to information about who else is involved. It would not be a surprise if bigger fish are still to come.
Third, Libor-rigging is defended as a "victimless crime." This is untrue. Traders at Barclays and other banks gained from this series of manipulations, so someone else lost. That may have been investors, who received lower returns than they would have otherwise. Or it may have been borrowers, who paid higher interest rate and related costs than would have been necessary in an honest market. Other losers are presumably everyone who was effectively overcharged by all the intermediaries involved in crooked behavior. Some local governments have also lost heavily – and at a time when these losses put pressure on essential services and will tend to increase taxes.
Honest people in the financial sector should be up in arms about the behavior of Barclays and other mega-banks.
Fourth, some contend that it is the regulators' responsibility and fault that there was cheating on Libor. It is certainly the case that there was regulatory capture at work, i.e., officials in Britain, the United States and perhaps elsewhere should have been paying closer attention. I made exactly this point on National Public Radio, in a discussion with Guy Raz and Matt Taibbi, last Saturday.
The mystique of the financial sector wowed many people – including many prominent policy intellectuals, Democratic and Republican – in the years before 2008. But who does the capturing in regulatory capture? Big banks work long and hard and lobby at many levels to push regulators toward paying less attention.
Fifth, the weakest argument is, "It was only a few basis points, here and there" (where a basis point is a hundredth of a percentage point, i.e., 0.01 percent). Either the Libor reporting process and, consequently, the pricing of derivatives has been corrupted by a criminal conspiracy, or it has not. There is no "just a little" in this context for the enormous global securities market.
Robert E. Diamond Jr., who resigned last week as chief executive of Barclays, reportedly said: "On the majority of days, no requests were made at all" to cheat on Libor. The Economist, which does not make a general habit of criticizing prominent people in the financial sector, observed, "This was rather like an adulterer saying that he was faithful on most days."
Mr. Diamond has fallen. Who is next? How will this play in American politics? There is still time for politicians on the right and on the left of the political spectrum to get ahead of the issue. Digging in around specious arguments in favor of price-fixing cartels is not the way to go.
Power corrupts, and financial market power has completely corrupted financial markets. Barclays and the other global mega-banks involved in fixing Libor have brought their own industry very low – completely destroying the legitimacy on which sensible financial intermediation needs to be based.
Who trusts a banker at this point? The collateral damage is enormous. Who in their right mind would buy a complex derivative product from Barclays or anyone else implicated in this growing scandal?
An edited version of this blog post appeared this morning on the NYT.com's Economix; it is used here with permission. If you would like to reproduce the entire column, please contact the New York Times.
