Tag Archives: Banking

So Tom Hayes Is Guilty. Who Else Is?

By James Kwak

Tom Hayes was a trader at UBS and Citigroup who was very, very good … at rigging LIBOR. This week, he was convicted in the United Kingdom of conspiring to manipulate the benchmark interest rate and sentenced to fourteen years in prison.

There’s little doubt that Hayes was guilty as charged. In his defense, he argued that he had no idea what he was doing was wrong. But contrary to what some armchair attorneys think, that doesn’t matter. In general, the famous mens rea (guilty mind) requirement isn’t that you know you are breaking the law at the time; it suffices if (a) you know you are doing a thing and (b) that thing is against the law. There’s no question that Hayes knew he was conspiring to rig LIBOR, and that’s enough for the prosecution.

And on one level, it’s good that he was convicted and got a stiff sentence. That prospect should help deter criminal activity of all kinds by bankers and traders who have historically been shielded by prosecutors’ unwillingness to go after individual defendants (except in insider trading cases).

But … Tom Hayes as the evil architect of the LIBOR-fixing scheme? Not so much.

As in so many cases, there are only two logical possibilities. Either Tom Hayes’s bosses at UBS and Citi knew what he was doing, in which case they are guilty as well. Or they didn’t know about a widespread conspiracy being conducted across the electronic communications systems of some of the most technologically sophisticated companies in the world, in which case they are recklessly incompetent.

When it comes to Tom Hayes, there is a lot of evidence for the former. Apparently, when he was being recruited from UBS in 2010, he boasted to a Citi executive about how he rigged LIBOR. Back in 2007, that same executive had said in an internal email, “We will continue to pressure the brokers to talk [LIBOR] down and generally press lower” — when asked by a colleague to help lower Citi’s own LIBOR submissions. When Citi attempted to hire Hayes, his boss at UBS tried to arrange a large bonus for him to stay, citing his “strong connections with Libor setters in London.”

It’s hard to believe that senior executives at UBS and Citi didn’t know that LIBOR was being fixed. If they weren’t in on it directly, it’s likely that they turned a blind eye — precisely because they knew that it was good for the bottom line. Hayes himself generated $260 million in profits for UBS in just three years.

When people make that kind of money for the bank — in markets that are supposed to be highly competitive — executives don’t want to know too much about what they’re doing.

As time goes by, it gets harder and harder to figure out how much of the largest banks’ profits is due to their legitimate operations and how much is due to their tolerance of illegal activity (money laundering, rate fixing, bribery, etc.). Maybe bank executives are so inept when it comes to internal wrongdoing because they like things that way. They want their employees pushing the limits of the law to maximize profits. (“If you ain’t cheating, you ain’t trying.”) And when people like Tom Hayes get caught, the bank itself gets away with a slap on the wrist because it’s too big to jail — and the CEO gets away by claiming ignorance. It’s a win-win strategy.

[Also posted on Medium.]

Michael Lewis!

By James Kwak

On the title page of my copy of The Big Short, in black ink, it says:

“For James Kwak

With admiration”

And then a scrawl that I take to be Michael Lewis’s signature. (Christopher Lydon got the book signed for me, since Lewis was on his radio show a few days before I was.) It may be the only book I’ve ever bothered to get autographed.

So I was especially happy to read that Lewis also wants to break up the big banks (hat tip Ezra Klein):

“Along with the other too-big-to-fail firms, Goldman needs to be busted up into smaller pieces. The ultimate goal should be to create institutions so dull and easy to understand that, when a young man who works for one of them walks into a publisher’s office and offers to write up his experiences, the publisher looks at him blankly and asks, ‘Why would anyone want to read that?'”

When Simon and I made that the centerpiece of the last chapter of 13 Bankers, I thought our chances were slim. When we wrote, in the epilogue to the paperback edition, that a proposal to do exactly that had been voted down, 61 to 33, in the Senate, I thought they had changed from slim to none. It’s still a long shot, but the issue hasn’t died, and if anything is getting more attention now, what with people like George Osborne threatening to break up banks if they don’t reform themselves. Perhaps it isn’t impossible.

Thomas Hoenig Read All of Basel III . . .

By James Kwak

. . . and doesn’t like what he sees. In a post for the Harvard Law School Forum on Corporate Governance and Financial Regulation, the former president of the Kansas City Federal Reserve Bank echoes some of the issues raised by Andrew Haldane, which I discussed earlier. The core problem, for Hoenig, is that Basel III “promises precision far beyond what can be achieved for a system as complex and varied as that of U.S. banking.” Banks were able to arbitrage the risk-weighted capital requirements of Basel II? Well, we’ll close all of those loopholes, one by one. But this cannot be done, given the incentives and power imbalances at work: “Directors and managers . . . will delegate the task of compliance to technical experts, and the most brazen and connected banks with the smartest experts will game the system.”

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Reports of Wall Street’s Death

By James Kwak

Gabriel Sherman wrote what I would call a hopeful article last week called “The End of Wall Street As They Knew It.” The basic premise is that the end of the credit bubble and the advent of Dodd-Frank mean lower profits, more boring businesses, and smaller bonuses on Wall Street—permanently (or at least for the foreseeable future). Sherman also says that the former masters of the universe are now engaged in “soul-searching”: “many acknowledge that the bubble­-bust-bubble seesaw of the past decades isn’t the natural order of capitalism—and that the compensation arrangements just may have been a bit out of whack.”

Call me a skeptic, but I’m not convinced. For one thing, there are few people quoted in the article who actually seem to be engaged in anything that might be called soul-searching (as opposed to complaining—like the now-clichéd banker who watches his spending carefully but has a girlfriend who likes to eat out). The story’s featured voices are ones that are not on Wall Street and have been critical of it for a long time, such as Paul Volcker and John Bogle. Another example of “self-criticism” comes from Bill Gross—but’s he’s on the buy side, not Wall Street.

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The Fourteenth Banker

By James Kwak

I wanted to bring your attention to a new blog that could turn out to be very important. It’s called The Fourteenth Banker (here’s why) and it’s hosted and written by a current banker who wants to see real change in the industry. This is from the About page:

“Despite being with a big bank, I support reform legislation ending TBTF, separation of Commercial and Investment banking, an independent consumer protection agency and other meaningful reforms.    Why?    I have seen first hand the perversions that happen because of some who believe that the an institution exists for them and the stockholders primarily.    Countless others have been hypnotized by this illusion as well.       Free market idealism is conveniently permissive of unbridled self interest.  I believe in the free market.   In fact, this blog is a free market of ideas and is meant to lead to a free market in banking where institutions self police as a matter of competitiveness.    I have hopes of a free market where being in community in a responsible and consistent way is the path to prosperity, a free market where we recognize that if we take care of the community, the community will take care of us.    It takes a sort of faith.    Or does it?     Is not all successful business enterprise based on providing more value than is consumed?

“That is why we are here.   I invite other bankers to engage in discussion about issues and excesses in our industry and possible solutions.”

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“Break Up the Banks” – in the National Review

By James Kwak

“Big banks are bad for free markets,” economist Arnold Kling (who usually blogs at EconLog) begins in the conservative flagship National Review, and it only gets better from there. “There is a free-market case for breaking up large financial institutions: that our big banks are the product, not of economics, but of politics.”

Like other conservative economists, Kling uses Fannie Mae and Freddie Mac as an example of financial institutions that grew too large through a combination of lobbying expertise and government guarantees . . . and frankly I agree with him. But he is equally unsparing of other large banks that were supposedly “pure” private actors but turned out to have their own government guarantees.

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Banks Paying Customers to Take Overdraft Protection

By James Kwak

I saw a bank ad in the subway yesterday. Basically, it said:

  1. If you set up direct deposit the bank will give you $100.
  2. If you set up overdraft protection the bank will give you $25.
  3. If you activate online bill pay the bank will give you $25.

1 makes sense because (a) it gives the bank more cheap deposits, which are its raw material and (b) it increases your switching costs. 3 makes sense because it increases your switching costs; it may also cause you to give the bank more cheap deposits, since you need money in the account to cover your bills.

2 makes sense because . . . the bank expects to get more than $25 in fees out of the average customer. A single overdraft fee typically costs more than $25. Now people will be making an explicit decision: “I want the $25 now because I don’t think I’ll ever pay an overdraft fee.” (To be fair, they might be thinking, “I already value overdraft protection at $35 per occurrence, so the $25 is just a bonus.” But I doubt many people think overdraft protection is worth $35 per transaction when the typical transaction is a lot less than $35.

There’s nothing illegal about this, and arguably it’s a smart business decision. It just makes things perfectly clear: the banks want those fees so much they are willing to pay you for them.