BOOSTERS of financial regulation are making hay from the widening scandal over allegations that LIBOR, a key interest rate, was rigged repeatedly for at least five years since 2005. Yet the trove of documents that have emerged also reveal the very flawed nature of regulation, in which government bureaucrats are asked to keep tabs on high-flying financial sorts. Transcripts of calls between officials at the Federal Reserve Bank of New York and traders at Barclays show that regulators didn’t really pick up on cues, even when they spelled out misbehaviour.
In one call between a Fed official named Tania and an unidentified trader, the Barclays employee says: “West, Deutsche, Landesbank (sic) I don't know where he gets his LIBOR indications from. I can't imagine anyone would want to lend him any money… you've had certain banks who I know have been paying 25 basis points over where they've set their LIBORs” Unfortunately Tania’s response is: “Alright, well thank you very much for your time. I appreciate it.”
The rigging of LIBOR leaves most regulators involved looking rather foolish, but none more so than Britain’s venerable Bank of England and its younger upstart, the Financial Services Authority. Despite officials like Tania, American regulators did at least begin investigating allegations and came up with with ways of improving the system. British officials seemed content to pass on some advice to the British Bankers Association (BBA), which oversees LIBOR. Mervyn King, the governor of the Bank of England, told parliamentarians that it wasn’t his responsibility to regulate LIBOR and that, in any case, the New York Fed hadn’t given him hard evidence that it was rigged, merely concerns that it might be.
In their defence, the LIBOR-rigging was taking place in the midst of a financial crisis. Most senior executives of banks and their regulators were more concerned with trying to prevent financial Armageddon than policing a rate that seemed, in any case, to be dysfunctional. Even so, when one contrasts the torpor of British officials with the energy on this issue of their American counterparts, one cannot help but feel that Britain’s regulators are out of touch.
Britain’s financial services industry is a national asset. It has thrived for many reasons that include London’s favourable time-zone that allows it to trade with Asia and America, as well as its networks of skilled bankers and other professions. High among its attributes, though, is its rule of law and the legal certainty that underpins this. The fact that Britain effectively set interest rates for the world was a great source of prestige and soft power. LIBOR should not have been so carelessly handled that it may now be destroyed for no other reason than that people have lost faith in Britain’s ability to play by and police the rules.
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Yay another 'regulatory failure'. I know how to fix it! Give these same regulators MORE POWER. (sarcasm)
How can it be 7 shades of criminal if private banks 'fix' the rate they charge interest to each other? (It is not at all obvious to me why this would be criminal) But, the FED does this as a matter of policy, and nobody blinks?
The FSA has pronounced this activity criminal by fining Barclays for it. Yet the head of the FSA claims not to have known. This is absurd
1) It was blatantly obvious to anyone with a half a brain cell
2) Not knowing should be a firing offence in and of itself
Adair Turner should be fired and banned from regulation work in future. As the financial regulator it was the FSA's job to monitor this rate. It does not reflect well on Merv or his underlings, but technically they were not responsible at the time.
For the City of London to survive as a leading financial centre, its regulators must be credible and neither the BoE nor the FSA come out of this with any credit. The Treasury should extract the maximum penalty from the top ranks of the regulators - who should walk away ashamed of their craven behaviour.
Simply stated, if the regulators aren't paying sufficient attention, why are they employed?
The present fines and regulator conclusions are a slap in the face to the general public. To little to late? Wake up!!
With respect to the arguemnts on regulation v. deregulation.
Coming form someone working in a highly regulated industry, there is plenty of regulation, just a lack of compliance (base on lack of core values) in some companies and ineffective enforcement.
Piling on more regulation that increases cost for the honest players in any industry, while providing no marginal benefit in policing the offenders, is not the solution.
Not being an economist, can someone explain to me the difference between the Federal Reserve using interest rates to impact economic activity and what the banks and regulators did with LIBOR?
It seems, in both cases, rates are being set at levels incosistent with acutal risk (in this case low) and there are relative winners and losers?
P.S. I understand the impact of low or high rates on debtors versus creditors.
The Federal Reserve tells you what it is going to do and why, they do not pretend that the change in the rate is the invisible hand of the market which nobody can specifically predict or control. The Federal Reserve does not place bets on which direction it is going to go tomorrow, then move it the direction that will make their bet pay off, making fools of investors who took the other side of the bet.
Thanks, I had thought about the transparency part, but still get confused by the economics of setting a rate inconsistent with actual risk. While the Fed may tell you when they set a rate, you have no ability to avoid the consequence of their annoucement on past transactions? If the rate setting is not consistent with actual risk, then neither is the impact on existing investments (positive or negative)?
Isn't the fact that "spread" is more important for users of LIBOR also a mitigator?
Sorry, may not be possible for me to form an understanding but appreciate your thoughts.
LIBOR is not set by the regulators but in theory by the market. A series of banks report their rates and these are averaged, excluding the two extremes (highest and lowest). There are in fact two rates in London: LIBOR for USD and EUROLIBOR for EUR. The EURIBOR is set the same way but based on the rates reported by more banks from all over Europe.
The problem is that there is no checking whether the reported rates are based on real transactions.
Thanks for the clarification.
As far as setting the rate at risk, the market, in theory, sets the price of risk, assuming the market is wide, and hard to artificially move. Few issuers of risk can pick the exact rate that the market values their own debt. That is why the coupon rate differs from the effective yield almost as soon as a security is issued: the market is constantly considering the risk and pricing the value of the stream of expected payments. Why does the Fed choose a lower rate than the market? To subsidize banks, of course. To give them money at a rate so low that they are guaranteed to make a profit if they lend at any rate at all as long as they get it back. The theory, back when debt was something consumers did not use much, was a method to encourage investment by businesses in productive capacity. Though there is nothing to say that this debt will not be issued for gambling on synthetic index funds, which provides no more value to the economy than a casino. Besides, risk is relative, and US debt is still "the risk free rate" which does not mean that there is no risk at all, but that it is about as little risk as you can get. If our banking system goes down, you don't want better investments, you want a hole in the ground, canned food, and some ammunition. (I find it hilarious that large banks give credit default swaps on US debt: if the US defaulted for more than a days late payment, who would be left standing to pay out these credit default swaps?)
Although I wasn't formulating the proper question; you actually answered it!
I agree with your comments on use of leverage for consumption or specualtion versus productive capacity.
Thanks again.
I am very glad to see someone asking this. I have been wondering the exact same thing.
How can it be 7 shades of criminal if private banks 'fix' the rate they charge interest to each other? (It is not at all obvious to me why this would be criminal) But, the FED does this as a matter of policy, and nobody blinks?
Anthony Hilton, the economics editor of The Evening Standard, started his presentation at the Jersey Finance Annual London Conference this year by telling the audience that he began his career in ‘The City’ in 1968. In that time he has experienced 5 recessions and 7 banking crises and after each event politicians and regulators resolved to legislate “so that another crisis would never happen!”
But they did bark. Were it not for FSA's notice to Barclays, published on June 27th, neither Schumpeter nor any other contributor above here would now be arguing about the whole sorry mess. Moreover, by July 2nd London's watchdogs went straight on from mere barking to actual biting, with Mr Diamond's abrupt and somewhat summary dismissal.
So the really interesting point is that nobody seems very happy nevertheless. To some — just clamouring to see real blood spilled out — both barking and biting were only too little too late, due to some conspiracy. But others have rather deeper concerns. They noticed the obvious rational gaps in the FSA's document (which entirely glosses over the inter-bank collusion issues clearly implied by its own indictment against Barclays) and also the outright unpleasantness of the following ambush against Mr. Diamond. Both these things may be worrying in themselves, since they suggest an essentially arbitrary — and hence ultimately inefficient — regulatory system.
Thus the issue is not really whether you are for or against regulation as such, as some simple socialist soul seems to imply also above here. It's what sort of regulation you need for effectiveness. And here, both history and Europe's liberal tradition agree in suggesting that the best option is the rule of law — rather than just the arbitrary power of some supposedly trusty alpha male.
In economic and financial matters the rule of law boils down to open and free competition within a framework of private property protection and enforcement of contracts. Yet, when it comes specifically to finance, one must keep in mind the practical fact of counterpart risk, which by itself tends to produce anti-competitive barriers. So open and free competition — of the sort that would make LIBOR rigging impractical — may require here some specific rules, much like what you need with natural monopolies. Yet, in order to work, such rules need be simple, well-known to everybody and uniformly enforced. Devising such rules is probably not beyond the powers of the human mind. But they may require to do away with the time-honoured closed club around the Old Lady of Threadneedle Street.
The Bank of England warned Barclays about its culture which fostered the manipulation even in February. But you are right, it was too late as rates were rigged even before the crisis. I found an interesting article showing that the EUROLIBOR was coherently lower than the EURIBOR already in 2009 (and one in 2010) but apparently no one reacted or the right people did not read it.
Economist is the guy who, after a financial disaster comes up to say " I told you " but who never saw the disaster coming up before it blew !
LOL, even worse than the weather man: at least that one can explain yesterday's weather...economists can't even explain what happened in the past :))))
Peter Schiff was right
http://www.youtube.com/watch?v=2I0QN-FYkpw
This is typical economist jive. So what are this Schumpeter fellow's riddles suggesting ? Regulation ? de-regulation ? either way he'd bark up the trees.
and yes, British standard (Libor in this case) was a security which I hope will survive and prevail at the end because there is no alternative at the moment.
Why didn't the watch dog bark?
Because that was its owner sneaking by.
The problem with British regulation is that there is a conflicting objective of protecting London's position as a global financial centre. That is why there is a reluctance to really clampdown on bad behaviour, lest it scare off market participants. Like with a sole inflation target for central banks, its time regulators were told to do their job with the sole consideration of ensuring market integrity, without worrying about whether business stays in London as a result.
Indeed you have the past thinking of UK regulators and their political masters correct.
Is therefore ironic that in the future the "light touch" regulation reputation of London is likely to scare off market participants concerned that domestic regulators and customers see them as being in London to get away with behaviour they dare not try elsewhere.
The problem with British regulation is that there is a conflicting objective of protecting London's position as a global financial centre.
Except, of course, that regulation is precisely what supports London's position. There are plenty of places where regulation is easier to non-existant. But would you really want to bank with someone who has no constraints upon how he uses your money? I sure wouldn't. Which was the point the author of the Schumpeter blog was making.
The LIBOR-related scandal is about supervision and not regulation. Everyone should pay more attention to supervision, ethics and morals in our daily activities. There is not that much wrong with the regulation and I have seen no substantive case that stack up against light touch regulation.
Sorry Jouris;
Not so. London was in the sweet whereby outsiders thought that the UK were competent regulators while in fact they were little better than the palm tree islands that people avoid because of lack of regulation.
Now reality catches up to London and those who are exposed to it.
If you want to see the results of light touch regulation go to London.
The problem is not that London's regulations were lax, though they were. The main problem is that, as Burgundy said, everyone involved was afraid to see them enforced lest the banks leave as they said they would.
The regulators didn't enforce LIBOR rules.
The regulators didn't enforce the Loan-to-Value rules in the US housing markets.
The regulators didn't enforce the rules to prevent money laundering by the Mexican drug cartels.
---
Either the regulators are former members of Congress, or they are doing nothing so they can say they have that experience when they decide to run for Congress.
NPWFTL
Regards
Should we mention HSBC being caught money laundring for drug cartels in Mexico, and having the guts to state they had no clue Mexico was at risk of corruption ?
Regulators should have clearcut and speedy ways to jail people until a judge deliberates they are good, and especially to confiscate their zillion dollars, fast. there is always time to give money back to a crook.
TE you have a pretty poor record of fighting regulators, for instance when Monty took Microsoft to court for hundreds of millions...and was stubborn enough to resist until they paid. Currently you praise the chap for his work as PM n Italy, but back then u were trashing him.
Or how about the SEC fining these super banks NEGOTIATING no criminal or fiscal charge in court ? Sickening.
If a poor mortal drinks and drives goes straight to prison, and rightly so. If a crook makes people go bankrupt then what ? His employer chips in a fine ???
"If a poor mortal drinks and drives goes straight to prison, and rightly so. If a crook makes people go bankrupt then what ? His employer chips in a fine ???"
Another example that shows money is just like drugs. Have you ever heard of drug barons going to jail other than in HIS own interest?
Yes we did many many times, be in Italy, US, or Latin America.
Indeed, one reads the accounts of ancient Greece and Rome, one reads of the rampant corruption and how panem et circenses were used to trick the population in bearing with those conditions, and cannot fail to see how moral costumes have chaged little in 2000 years.
O tempora o mores, well no tempora...mores are the same.
Aha the old blame-the-regulator trick! As have been pointed out before; the regulators are toothless because respected financial opinion makers like TE relentlessly have pushed for less and and less regulation.
Pointing the finger at the regulators now for not regulating enough is disingenious at best. Hypocritical and shameless at worst.
Even so, when one contrasts the torpor of British officials with the energy on this issue of their American counterparts, one cannot help but feel that Britain’s regulators are out of touch.
As it is being reported that Barclays was in close contact with the Bank of England over the auction, it may be high time that you suspected that the LIBOR rigging was an unconventional and rather exotic form of ‘monetary easing’ attempting to reduce the market rates of interest when the key rates of interest were extremely low, while QE is unconventional but not really exotic.
High among its attributes, though, is its rule of law and the legal certainty that underpins this.
That’s all the more why the exchanges of words between the banks – for the exotic form of monetary easing – were done under the counter when the authorities were desperate to reduce the market rates of interest further when the key rates of interests had already been minimum in effect.
The fact that Britain effectively set interest rates for the world was a great source of prestige and soft power. LIBOR should not have been so carelessly handled that it may now be destroyed for no other reason than that people have lost faith in Britain’s ability to play by and police the rules.
Perhaps the British economy is not as credible as it is being estimated in the first place. Britain’s spread between the key rates of interest and the market rates of interest could even be larger. It implies that the Sterling is being overestimated considerably, and hence a quantitative easing by the BoE could jeopardise it much more likely than one by the Fed could jeopardise the US economy. If they thought they could go on hiding the rigging for ever it is natural that the exotic form of monetary policy appeared more favourable than QE to them.
I speculate that the view will sooner or later become dominant in public that the LIBOR rigging was a form of monetary easing – a crime of conscience, sort of.
It is not that I am for such a shady form of monetary policy but that I am saying the British economy may be more cornered than has been estimated.
Overall, a very cogent argument (@jasiek)