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Post Partisan
Posted at 02:52 PM ET, 07/06/2012

The banking scandal Wall Street fears

When did you stop believing Wall Street’s promises that the latest banking scandal was a one-off and would never happen again? For many who were still credulous, the tipping point may have come this week, with the London interbank offered rate (Libor) rigging scandal.

Libor (and its European counterpart, Euribor) are benchmark interest rates, calculated each day after traders at leading banks estimate the rates at which their banks could borrow money. Libor is then used to “to set interest rates on $350 trillion of dollars and euros of loans and other obligations globally.” Yes, $350 trillion. If you have a credit card, a car loan, a student loan or a thousand other common loans, including an increasingly high percentage of mortgages, there’s a good chance your interest rate is indexed to Libor. (My Post colleague Dylan Matthews has a more extensive summary.)

The affair first hit the public spotlight last week, when Barclays Bank agreed to pay a $450 million fine to U.S. and U.K. regulators. But Barclays is only the first domino: Between 15 and 20 banks have been named in various Libor-rigging investigations or lawsuits throughout Europe and North America. “This is the banking industry’s tobacco moment,” the chief executive of a multinational bank told the Economist. “It’s that big.”

The Libor rigging came in two flavors, but rarely have two parts so well crystallized the problems in regulatory and banking culture. The less sinister of the two bouts of rigging is the later one, from 2008, when Barclays and a number of other banks allegedly kept their rates low to hide the poor state of their balance sheets. On its own, this is bad enough: Though keeping the interest rates low helped consumers in the short run, they disguised the extent to which the banks were in danger.

Worse, though, is emerging evidence suggesting that some regulators may have encouraged banks to keep those rates artificially low. As Noam Scheiber noted, the rigging shows once again that,

in order to get corruption in your banking system, you don’t need literal corruption of the Government Official X owns shares in Bank Y variety (or even Official X wants to work at Bank Y after he leaves government). You just need banks big enough so that the bureaucrats keeping an eye on them have nightmares about what happens if the banks fail. At that point the bureaucrats will dedicate themselves to keeping the megabanks afloat at all costs, even it requires methods that aren’t on the up and up.

Prior to 2008, though, Libor rigging was only about the bottom line; the banks’ submitters would work with its derivatives traders to vary its reported rates and bolster the banks’ profits. Dylan Matthews summarizes:

For example, it could have placed bets that the LIBOR rate would increase, and then reported artificially high rates which in turn artificially increased the LIBOR averages, so that the bets were likelier to pay off. This not only screwed the investors on the other side of the trade, but bumped up mortgage rates – however infinitesimally – for consumers even when the risk of the loans hadn’t changed at all.

And Barclays apparently wasn’t alone in this rigging: It also colluded with other banks, with traders exchanging requests for their counterparts’ submitters. The widespread collusion, writes the Economist, “looks less like rogue trading, more like a cartel.”

The obvious first step, of course, is to prosecute the banks involved as thoroughly as possible. The traders and submitters directly involved in rigging-for-profit should go to jail. (Individual prosecutions could be brought under the federal wire fraud statute.) But to ensure that such behavior doesn’t continue, that the financial sector gets the message, the banks’ senior management must also finally face the music. We’ll hear the typical excuses: The leaders had no idea this was going on, even though the Financial Times and others have been reporting on this since 2007. And even when they did learn, it was only a few rogue traders and their immediate supervisors who were responsible, not the senior leadership. Also, the leaders accused of being involved should keep their huge pay packages and bonuses, because they earned those piles of money with their smarts and hard work. You may laugh, but this is what now-departed Barclays CEO Bob Diamond argued on Thursday before the British Parliament.

One hopes that even those most inclined to give the big banks the benefit of the doubt would recognize the common trait running through these excuses: cowardice. It takes little effort or intelligence to make a profit when you’re setting a rate and betting on that rate at the same time, or to scam cities when you’re bribing city officials, or to sell millions of dollars in worthless bonds when you’ve neutered the rating industry that is supposed to grade them. And what does it say about the character of our financial “titans” that they still scramble to socialize risk through Too Big to Fail, to foist false blame for the crisis on the housing market, and to duck and dodge around every new attempt to return some accountability to the industry? The Libor scandal is teaching once again (and to an ever-wider audience) that lesson the big banks most fear people taking to heart: Their industry, right now, is rotten to the core. 

By  |  02:52 PM ET, 07/06/2012

 
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