As the Libor scandal intensifies, some of the scrutiny has shifted from the role of the banks to the role of the regulators who potentially either actively ignored the rate-rigging happening under their noses, or outright encouraged it. This was the accusation leveled by former Barclays Bank CEO Bob Diamond (who stands to still get his full salary and benefits despite the resignation) at the Bank of England, who he said intimated that the bank’s Libor submissions were coming in too high, creating a perception that the bank was in financial trouble (which it was at the time, so this suggests the Bank of England wanted to cover that up).
Yesterday, Bank of England deputy governor Paul Tucker denied any encouragement:
Mr. Tucker testified that while senior officials had maintained regular contact with senior managers at Barclays after the collapse of Lehman Brothers in 2008, he was not informed of the effort to manipulate the London interbank offered rate, or Libor. The rate is used as a benchmark for trillions of dollars of corporate loans, home mortgages and derivatives around the world.
“I was not aware of allegations of lawbreaking until the last few weeks,” Mr. Tucker said during more than two hours of questioning [...]
The British official said his phone call to Mr. Diamond was to remind the Barclays chief that people in the markets were questioning whether the British bank had access to financing.
“I wanted to make sure that Barclays’ day-to-day funding issues didn’t push it over the cliff,” Mr. Tucker said.
More from The Guardian on yesterday’s hearing before Parliament. At least one MP openly stated that “We have what appear to any reasonable person as the lowballing of rates.”
We’re right at the beginning of finding out what role any of the central banks might have played in fixing the Libor. But we have enough information to know of the regulatory paralysis in the face of this scandal. Reuters reports today that the Federal Reserve Bank of New York knew as far back as 2007, when it was under the direction of current US Treasury Secretary Timothy Geithner, about the Libor rigging. The NY Fed even offered proposals to London for reforming the Libor process back in 2008.
The role of the Fed is likely to raise questions about whether it and other authorities took enough action to address concerns they had about the way Libor rates were set, or whether their struggle to keep the banking system afloat through the financial crisis meant the issue took a backseat.
A New York Fed spokesperson said in a statement that “in the context of our market monitoring following the onset of the financial crisis in late 2007, involving thousands of calls and emails with market participants over a period of many months, we received occasional anecdotal reports from Barclays of problems with Libor.
“In the spring of 2008, following the failure of Bear Stearns and shortly before the first media report on the subject, we made further inquiry of Barclays as to how Libor submissions were being conducted. We subsequently shared our analysis and suggestions for reform of Libor with the relevant authorities in the UK.”
The fact that the regulators knew about Libor rigging and did little to stop it fits in line with practically all other actions during and after the financial crisis. The emphasis was on keeping the financial system alive and afloat. Stress tests were ginned up, mortgage and foreclosure fraud not prosecuted, wrongdoing given slaps on the wrist with settlements far short of the crime committed, AIG counter-parties were paid off at par. Why wouldn’t we believe that central banks sought protection for the financial system rather than enforcement for lawbreaking in the context of Libor?
A recent survey of senior executives in the financial industry showed that around 1/4 believed they needed to engage in illegal conduct to be successful. The role of the regulators, in the context of an industry built in large part on fraud, seems to be to ensure that fraud doesn’t percolate to the surface and undermine the current banking structure. So who cares if $350 trillion in financial products were based on faulty numbers? Who cares if the rate that helps shape those $350 trillion in products was being changed based on traders calling in favors? As long as Goldman Sachs and JPMorgan Chase survive until tomorrow, all is well.
Regardless of whether you think that ordinary people suffered for all this gaming of the Libor (and in the case of local governments, it increasingly looks like they did), the massive amounts of wrongdoing here should end speculation about the health of our financial system:
The real issue is just that international finance has become a ruthlessly competitive game in which firms relentlessly seek newer and bigger profit opportunities. At the same time, important swathes of the system are stuck in the days of the old boys’ club where important measures were handled essentially as gentlemen’s agreements. Setting the Libor through a fairly informal submission system and then using it as the basis for global interest payments created a massive arbitrage opportunity: Anyone who was willing to game the gentlemen’s agreement could arrange vast, riskless profits. And today’s cutthroat finance is nothing if not brilliant at arbitrage. In particular, it’s gotten frighteningly good at arbitraging away effective regulatory oversight. Time and again problems have arisen when clever bankers have found clever ways of undermining the intention of regulatory systems. The Libor malfeasance lays bare in an unusually clear way the basic fact that a modern bank is perfectly happy to lie when there’s money to be made.
It’s appropriate to indict regulators in this context. They enable this conduct through their actions, or lack thereof. They have not responded in any effective fashion to the ruthlessness of the financial sector. Indeed, given the revolving door, Big Finance and the regulators are increasingly one and the same. You can make all the regulations you want, but it doesn’t matter if you have the same group of pliant regulators.