In the wake of the eruption into full public view of the scandal over the fixing of LIBOR, as 'Harper' noted in a post some days ago, the Financial Times called for a return to the full separation of retail and investment banking, such as prevailed in the U.S. under the Glass-Steagall Act between 1933 and 1999.
A report in the same paper has now suggested that traders at the British bank Barclays, which has been the principal focus of the coverage of the scandal so far, may have been the ringleaders in a coordinated effort to manipulate EURIBOR – the European equivalent of LIBOR.
Banks involved in this collusive fraud, it is suggested, included Crédit Agricole, HSBC, Deutsche Bank, and Société Générale. And this, together with the fixing of LIBOR – which it seems likely, came to involve a wide range of banks worldwide, including major American and Japanese institutions – appears to have been routinely practised by Barclays, prior to the onset of the financial crisis.
As the two benchmarks, calculated for a variety of currencies on the basis of an average of submissions from banks about how much it costs them to borrow from other banks, are the basis of which trillions of dollars worth of financial contracts are valued, the potential ramifications of the various investigations now underway into their fixing are immense. And it is doubtless unsurprising that a recent report in the New York Times, under the title 'U.S. is Building Criminal Cases in Rate-Fixing' explained that the LIBOR case, 'presents a potential opportunity for prosecutors.' It continued:
Given the scope of the problems and the number of institutions involved, the rate-rigging investigation could provide a signature moment to hold big banks accountable for their activities during the financial crisis.
It may seem curmudgeonly, cowardly, or both, to regard this prospect with anything less than unqualified enthusiasm. However, an exclusive focus on the delinquencies of selected scapegoats during the financial crisis may divert attention from questions more directly relevant to understanding how the crisis came about and how what now seems an almost inevitable recurrence might perhaps be prevented.
Involved here, moreover, are not simply the actions of élites, but the way many of their members have become accustomed to think. And some of the issues raised by the LIBOR and EURIBOR scandals about how élites think about economics may overlap with questions about how they think about foreign affairs which have been discussed on SST over the years.
A recurrent theme of Colonel Lang's posts has been the way that ideological blinkers, among them those involved in 'rational choice' theorising popular in areas of the 'social sciences', make impossible any kind of adequate understanding of alien societies. A question which needs to be confronted is whether such blinkers also make it impossible to understand our own.
The sheer scale of the transactions influenced by the various LIBOR rates has meant that, in addition to possible criminal cases, civil suits have already been brought, and more are likely. In a feature article entitled, 'The rotten heart of finance: A scandal over key interest rates is about to go global', the Economist explained that:
The number that the traders were toying with determines the prices that people and corporations around the world pay for loans or receive for their savings. It is used as a benchmark to set payments on about $800 trillion-worth of financial instruments, ranging from complex interest-rate derivatives to simple mortgages. The number determines the global flow of billions of dollars each year.
Clearly a very large number of institutions may have grounds for claiming to have lost significant sums as a result of the manipulation of LIBOR and EURIBOR. In the United States, two dozen lawsuits have already been filed, including one by the brokerage Charles Schwab in California, and a class-action led by the City of Baltimore in New York – and these have apparently already been consolidated into a single case.
An invaluable source of information about all this is a series of posts, starting with this one, by the New York management consultant Susan Webber, who runs the Naked Capitalism blog under the pen-name 'Yves Smith'. In a subsequent post, drawing on research from Morgan Stanley, she surveyed estimates of the possible cost to the banks of civil suits.
Among the 16 banks involved in the class action suit, in addition to Barclays, are Bank of America, Citigroup, JP Morgan, Credit Suisse, Deutsche Bank and UBS, HSBC, Lloyds, and Royal Bank of Scotland. The Morgan Stanley figures add in the French bank Société Générale for good measure, and calculate the potential costs of civil actions on the basis of an estimate of an average 35 basis points underreporting of LIBOR for all these institutions for the period 2007 to 2011. As one basis point is a hundredth of a percent, this means that thekind of scale of effect one could be talking about for the manipulation could have been 0.35% of very large sums indeed.
A 'locust swarm of litigation'?
At the moment, however, we simply do not know whether the the fixing of LIBOR and EURIBOR is likely to provoke what Yves Smith, in another post, termed a 'locust swarm of litigation', which could effect the solvency of banks as well as their reputation – or whether this will all turn out to be a storm in a teacup. A more recent attempt at quantification by Nomura concludes that depending upon the assumptions one makes, one can end up with potential exposure on the part of the relevant banks ranging from 'a few billion to hundreds of billions.'
And Nomura also points to a number of reasons why the complexity of the whole affair may make it difficult to make either civil or criminal cases stick – and why those involved, including regulators, 'may be persuaded at some point to pursue the settlement route.'
Certainly, other banks may see the wisdom of following Barclays in cooperating with the investigators. As a result, the $453m./£290m. fines levelled in the bank's settlements with the Commodity Futures Trading Commission, the Department of Justice, and the (British) Financial Services Authority incorporated a 30% reduction in the penalty. It is now reported that Deutsche Bank is cooperating with German investigators, under a European Union leniency programme.
What is however already clear from the evidence emerging from the investigation of Barclays by the CFTC, the DoJ, and the FSA – see here, here and here – is that the issues involved in the fixing of LIBOR before and after the onset of the financial crisis are markedly different. While the evidence suggests that figures from Barclays may have been ringleaders in the manipulation of EURIBOR, and were also routinely manipulating LIBOR, prior to the crisis, after its onset the bank appears to have been a laggard, rather than a leader.
Before the onset of the crisis, according to the CFTC, 'LIBOR generally was a stable rate with minute fluctuations' – the range among submissions was narrow, and indeed the banks involved 'frequently submitted the same rates.' The structure of the fixing of the U.S. dollar rate, with submissions from a panel of 16 banks, with the highest and lowest 25% excluded, would in any case make it difficult for a single bank greatly to affect it. Submissions which were radically out of line would not only have risked drawing attention – they would have been excluded.
The kind of routinely practised distortion suggested in the graphic e-mails from Barclays traders quoted in the settlement documents appears to have been of the order of a single basis point, or even less. And the resulting difference to the average figure could have been expected to be much less than that. That significant profits and losses could be made by such variations reflected the sheer scale of the sums involved in the contracts involved. In one e-mail, the figure involved is quoted as $80bn.
Cumulatively, small percentages of vast sums would make a significant difference both to the trading profits of an institution – and even more, to the remuneration of the traders involved. Accordingly, there were strong 'rational' incentives for the traders to want LIBOR adjusted. What the CFTC, DoJ and FSA documents do not I think explain is what the incentives would have been for the 'submitters' who accommodated the traders – which is among the various reasons to be concerned that investigators have been too happy to accept a 'rotten apples' theory of what was happening.
Collusion with 'submitters' in other banks, obviously, could make it easier to have a material influence on both LIBOR and EURIBOR. And given that the EURIBOR panel involved between 42 and 48 banks, with the top and bottom 15% excluded, it is not surprising that there seems to have been a great deal more collusion with this rate than with U.S. Dollar LIBOR.
From June 2005 through until September 2007 – that is the month after conditions in credit markets began to deteriorate very significantly – Barclays traders appear to have been putting in requests to adjust LIBOR submissions in ways that favoured their trading positions as a matter of routine. Thereafter, the requests were, to quote the DoJ, 'made occasionally.'
Even if the 35 basis points average used by Morgan Stanley is substantially overstated, the defrauding of counterparties would clearly have had far less impact prior to the onset of the financial crisis. Accordingly, it remains a moot point whether civil suits will at any point cast light on events prior to 2007.
An important question is whether the 2005 cutoff indicates that there is no reason to suspect LIBOR fixing prior to that date. Interestingly, given that the Economist has hardly been conspicuous for a propensity to ask awkward questions about the financial services sector, it suggests that there is:
The FSA has identified price-rigging dating back to 2005, yet some current and former traders say that problems go back much further than that. "Fifteen years ago the word was that LIBOR was being rigged," says one industry veteran closely involved in the LIBOR process. "It was one of those well kept secrets, but the regulator was asleep, the Bank of England didn't care and…[the banks participating were] happy with the reference prices." Says another: "Going back to the late 1980s, when I was a trader, you saw some pretty odd fixings…With traders, if you don’t actually nail it down, they’ll steal it."
According to the CFTC, meanwhile, Barclays lacked 'specific internal controls and procedures' which would have brought the fixing of interest rates to the attention of management. However, we are also told that the 'primary Euribor submitter' was 'the expert on the Euro money markets', who 'had 20 years experience in the London money markets and had been with Barclays for over 35 years.'
So, in addition to the puzzle about what incentive the 'submitters' had to accede to the requests from the traders, we have a further puzzle arising from the fact that we are quite patently not simply dealing with adrenalin-fuelled twenty-somethings running amuck. Lack of controls would seem to indicate that Barclays senior management were either fools or knaves. It could imply that the whole notion that those in charge of major European banks knew what they were doing was nonsense. If collusive corruption at four such banks did not come to the notice of senior management at any, this would appear to indicate that the institutions were out of control.
Equally, however, it could be that senior management at Barclays, and elsewhere, knew very well what they were about, were complicit in the fixing, and did not want internal controls because they would have made trades profitable to the bank and to them personally impossible. Whether the CFTC is justified in assuming that folly, rather than knavery, is the correct solution to the puzzle they fail to confront would seem a moot point.
So, at this stage, we know rather little about the fixing of LIBOR, and EURIBOR, prior to the onset of the financial crisis. It may be that all that was at issue, at this point, was 'rotten apples' at Barclays corrupting 'submitters' at their own and other European banks. Equally however, it is possible that all we have so far seen is the seen is the tip of an iceberg of systemic corruption going back decades.
The situation following the onset of the financial crisis was clearly quite different. And indeed here there is a certain area of unreality about the investigations into LIBOR fixing, which actually reflects the element of unreality in the events being described. A key passage in the 'Statement of Facts' by the DoJ runs as follows:
During approximately November 2007 through approximately October 2008, certain employees at Barclays sometimes raised concerns with individuals at the BBA [the British Bankers' Association], the Financial Services Authority, the Bank of England, and the Federal Reserve Bank of New York concerning the diminished liquidity available in the market and their views that the Dollar LIBOR fixes were too low and did not accurately reflect the market. In some of those communications, those employees advised that all of the Contributor Panel banks, including Barclays, were contributing rates that were too low. Those employees attempted to find a solution that would allow Barclays to submit honest rates without standing out from other members of the Contributor Panel, and they expressed the view that Barclays could achieve that goal if other banks submitted honest rates.
A revealing phrase comes in instruction from management to the 'submitters' to stay 'within the pack' in their submissions, and the suggestion made in internal communications that the purpose of under-reporting was to keep Barclays's 'head below the parapet' so that it did not get 'shot' off.
So in the sharpest possible contrast to the earlier period, in the later period Barclays was not a ringleader – but at key points was being pulled along, with some reluctance, by the 'pack' of other banks. The background to this is that, by this time, the whole process of LIBOR fixing had become little short of surreal.
The process presupposes that there is sufficient interbank lending for realistic figures on the cost of borrowing significant sums to be available. But as the financial crisis worsened, interbank lending dried up, because banks did not have sufficient confidence in each other's solvency to lend significant sums on maturities above one month.
A situation where bankers' actions – as distinct from their words – are based upon the assumption that most other banks could actually be insolvent is one fraught with potentialities for a catastrophic kind of 'herd' behaviour common in financial panics – where perfectly 'rational' suspicions of collapse become self-validating. And as the CFTC document makes clear, the high LIBOR submissions by Barclays in the U.S. Dollar, Euro and Sterling markets in the period when the credit stress was becoming acute helped prompt a flurry of speculation by Bloomberg and others in September 2007 about its liquidity position.
In fact, situations where attempting to stand aside from 'pack' or 'herd' behaviour is suicidal are not uncommon – and they certainly recur quite frequently in financial markets. One of the reasons bubbles recurrently inflate and collapse is quite precisely that it can be quite 'irrational' for investment managers to point out that the 'herd' has lost contact with reality – those having the temerity to do so are liable to lose all their clients. Likewise, a single bank that tells the truth about its borrowing position when others are lying about theirs will risk giving the impression that those others consider each other solvent, while the high figures it is reporting indicate that everyone think it headed for bankruptcy – which could be a self-validating impression.
And such considerations may also be relevant to the – hardly insignificant – question as to whether the Bank of England was complicit in the fixing of LIBOR. A crucial point at issue here relates to the interpretation of a telephone conversation on 29 October 2008 between a deputy governor of the Bank of England, Paul Tucker, and Bob Diamond, then chief executive of Barclays Capital, the investment banking arm of Barclays. A great deal of attention has focused on this conversation, both in the investigation by the Treasury Select Committee, and in the media coverage. But much of the attention has generated as much heat as light.
It is clear that, following this conversation, the Barclays 'submitters' did reduce their figures. According to the FSA, moreover, they 'believed mistakenly that they were operating under an instruction from the Bank of England'. This impression, it is suggested, was erroneous, resulting from a 'misunderstanding or miscommunication' in the 'chain of command'.
Unsurprisingly, neither the FSA, nor the CFTC or DoJ, wanted to accuse the British authorities. When however Barclays published what was in essence their defence, it concluded with an e-mail relating the contents of his conversation with Tucker sent by Diamond to two colleagues. In this, Tucker was quoted as saying that, in relation to the figures which Barclays had given, while he was 'certain' that Barclays did not need advice, 'it did not always need to be the case that we appeared as high as we have recently.'
However, Barclays did not contradict the FSA account, suggesting that Tucker's remarks had not been meant as an instruction, and had not been interpreted by Diamond as such. It did however explain that the supposed 'misunderstanding' or 'miscommunication' was actually the doing of one of the recipients of the e-mail, Jerry del Missier, who was not some anonymous middle-ranking official, but the President of Barclays Capital.
Predictably, del Missier refused to accept responsibility, claiming that, before issuing the instruction, he talked to Diamond, who told him that Tucker had said that the Bank was 'getting pressure from Whitehall about the health of Barclays and that we should get our Libor rates down' – and that they should not be 'outliers'.
In fact, the e-mail is ambiguous. To make adequate sense of it, one would need an adequate understanding of why Barclays, which appears to have been a ringleader in LIBOR fixing prior to the crisis, was less enthusiastic than others after its onset. My guess would be that del Missier's account is closest to the truth, and that Diamond told him that Tucker had given an instruction because that was in effect the case. However, one cannot simply rule out the possibility that the e-mail was less instruction than permission – and that del Missier hardened matters up, perhaps because of unease among the 'submitters'.
What we however know is that even if it was an instruction, Tucker would insist that it was not, and that Diamond would fight shy of accusing the Bank of England, and so be left with the choice between falling on his sword and passing the buck downwards – with the latter option obviously being preferable. Accordingly, it is simply inconceivable that Tucker, or indeed others involved, will say publicly what many may very well think privately: that in the conditions prevailing at the time of the conversation, an accurate representation of the state of mutual distrust between major financial institutions was simply too risky.
Of course, such a judgment might have been wrong. As the DoJ makes clear, employees of Barclays were suggesting to authorities on both sides of the Atlantic that if other banks submitted more accurate rates, Barclays could do so without risk. And it may be that if everyone together had submitted an honest account of the terms on which they could have borrowed, there would have been no untoward consequences. So perhaps Paul Tucker should have got on the 'phone to Timothy Geithner at the New York Fed, and said something along the lines of 'if I lean on British banks to tell the truth, you can lean on their American counterparts – and we can then have an honest LIBOR, and all will be fine.'
As the Barclays evidence makes clear, market conditions improved rapidly in the days following the conversation, making the under-reporting of LIBOR unnecessary. However, it is not clear that either Tucker or Diamond could have been expected to anticipate that on 29 October 2008. Earlier that month RBS had been part-nationalised, while Halifax Bank of Scotland had been taken over by Lloyds and the amalgamated company also part-nationalised. This followed the collapse of Lehman Brothers the previous month – and the nationalisation of Northern Rock the previous February.
If I have gone into some detail about the specific history of Barclays at this point, it is because looking at that history closely raises the question as to whether the suggestion in the New York Times that the rate-rigging investigation could provide a 'signature moment' to 'hold big banks accountable for their activities during the financial crisis' may be more ambiguous than it looks.
What emerges about the behaviour of other banks during the financial crisis – including other British banks like RBS, and banks in Europe, the United States, and Japan – we will have to wait to see. In relation to the evidence presented by the CFTC, DoJ, and FSA, however, about the behaviour of Barclays during the financial crisis, I have difficulty seeing much which is not explicable by a natural desire of the leaders and staff of an institution to survive.
Likewise, although the accounts of the behaviour of the Bank of England in the accounts given by the CFTC, DoJ and FSA clearly pull their punches, even if in fact both British and other central bankers were complicit in rate-rigging, it would still need to be argued that there were better courses of action open to them.
Once one gets this far, however, one come up against what to my mind are more serious issues than that of rate-rigging during the financial crisis. What has to be explained is how we got into an impossible situation, where indeed there may have been no realistic alternative for leading banks to rigging LIBOR and other rates, and for officials to being complicit in or even encouraging fraudulent behaviour by the banks.
And that involves questions about how we ended up in a situation where it could legitimately be judged simply impossible to let market disciplines operate on significant financial institutions – and Northern Rock, after all, was hardly a megabank – because of the potential repercussions. And it also involves questions about how such institutions ended up so fragile that mutual lack of confidence in their solvency was so pervasive that submissions in relation to LIBOR became little short of surreal.
Most important of all, it involves questions about why, despite the financial crisis, essentially the same situation prevails today. In relation to Bob Diamond and his fellows at other 'megabanks', the astounding element is not primarily what they got up to during the financial crisis, or even, although to a lesser extent, what they may have got up to before it. The most amazing feature is their confident assumption that, in the wake of the crisis, there could be a rapid return to business as usual.
Of course it may be that this simply reflects the fact that 'business as usual' produces such inordinate short-term profits for bankers that they do not feel the need to worry about the longer term. However, such an interpretation may be simplistic -- and indeed, overly cynical. As Yves Smith observed, following Diamond's testimony to the Treasury Select Committee, his 'disconnectedness, whether genuine or clever posturing, sounds like the view from Versailles, circa 1780.' And indeed, the strong impression one gets of bankers in Britain is not that they have been aware of the rising tide of hatred felt for them by large sections of the population and indifferent to it -- but that they have been living in a cocoon.
There are many dimensions to the question of how we got into the extraordinary situation in which we found ourselves following the financial crisis. In addition to the behaviour of bankers, however, one also needs to look at the attitudes of many mainstream economists before and after the onset of the crisis. Prior to its onset, mainstream economists had, by and large, convinced themselves that the kind of catastrophic collapse which has been a recurrent feature of capitalist economies over the centuries was a thing of the past. And, as with bankers, the fact that they were so badly wrongfooted seems to cause strikingly little concern. In a post on Yves Smith's site, the former New York Fed economist Richard Alford observes that:
Economic policymakers, pundits and academics continue to forecast the future course of the economy and predict the effects of possible policy initiatives with an air of scientific certainty.
And their confidence, he notes, continues despite the fact that 'only a small minority of economists and none of the central banks and treasury/finance ministries anticipated the financial crisis and the recession'.
Of course, the persistence on the part of the financial sector in patterns of behaviour which have already produced a catastrophic blow-up, and are clearly likely to produce another, can simply be attributed to lack of any kind of integrity – as, to a lesser extent and in a different way, can the complacency of economists.
The last thing I would want to do is to belittle the importance of the issue of integrity. Indeed, among the many problems with the notions of 'rationality' as used by economists is a kind of prim reluctance to face up to the fact that fraud – as in the fixing of LIBOR prior to the onset of the financial crisis – may be perfectly 'rational' in in the sense in which they use the term. And so indeed can other forms of crime.
But although I have no desire to act as an apologist for bankers – or indeed economists – too exclusive a focus on the issue of integrity can blind one to some real puzzles. Commonly, one expects of the élites in a system that – whatever else may be held against them – they will be impelled by 'rational' considerations to ensure its survival. It is indeed the fact that Diamond and those like him seem so insouciant both about the prospect of another catastrophic melt-down – and also the potential long-term implications of the hatred they have aroused – which is puzzling.
And this brings me back full circle, to questions to do with foreign affairs. Discussing the issues involved in 'assassination by robot' some while back, Colonel Lang made some remarks about the civilian defence 'intelligentsia' which may also perhaps illuminate the behaviour of bankers – and economists:
The civilian defense "intelligentsia" occupy a world of their own in; universities, think tanks, federally funded research institutes, and associated journalism. They are, in many ways, a closed club. I notice that many of these people do not have interests outside their trade. Film, literature, the arts, these things are thought of as frivolous distractions from the serious business of reading each others' papers, and stroking each other at meetings. As in any pseudo scholarly grouping, the level of "group think" is striking. The main thing in any such guild is to remain acceptable to the consensus, and so consensus must be sought, even if the consensus is a proclivity for killing.
Perhaps in dealing with bankers, and economists, as with the 'civilian defence ''intelligentsia''', we need to focus more on the collective dynamics of what are actually curiously isolated and self-absorbed cultures. It may be no more appropriate to understand their behaviour in terms of an exclusive focus on the 'rational' choices of individuals than it would be with an Afghan tribe.