By Simon Johnson. For more discussion of these issues, listen to NPR’s All Things Considered, July 7, 2012.
On Monday, Bob Diamond – the CEO of Barclays, one of the largest banks in the world – was supposedly the indispensable man, with his supporters claiming he was the only person who could see that global megabank through a growing scandal. On Tuesday morning Mr. Diamond resigned and the stock market barely blinked – in fact, Barclays’ stock was up 0.3 percent. As Charles de Gaulle supposedly remarked, “the cemeteries are full of indispensable men.”
Mr. Diamond’s fall was spectacular and complete. It was also entirely appropriate.
Dennis Kelleher of Better Markets – a financial reform advocacy group – summarized the situation nicely in an interview with the BBC World Service on Tuesday. The controversy that brought down Mr. Diamond had to do with deliberate and now acknowledged deception by Barclays’ staff with regard to the data they reported for Libor – the London Interbank Offered Rate (with the abbreviation pronounced Lie-Bore). Mr. Kelleher was blunt: the issue in question is “Lie More” not Libor. (See also this post on his blog, making the point that this impacts credit transactions with a face value of at least $800 trillion.)
Mr. Kelleher’s words may seem harsh, but they are exactly in line with the recently articulated editorial position of the Financial Times (FT) – not a publication that is generally hostile to the banking sector. In a scathing editorial last weekend (“Shaming the banks into better ways,” June 28th), the typically nuanced FT editorial writers blasted behavior at Barclays and nailed the broader issue in what it called “a long-running confidence trick”:
“The Barclays affair may lack the spice of some recent banking scandals, involving as it does the rather dry “crime” of misreporting interest rates. But few have shone such an unsparing light on the rotten heart of the financial system.”
The editorial was exactly right with regard to the cultural problem – within that Barclays it had become acceptable or perhaps even encouraged to provide false information. It underemphasized, however, the importance of incentives in creating that culture. The employees of Barclays were doing what they were paid to do – and the latest indications from the company are that none of their bonuses will now be “clawed back”.
Martin Wolf, senior economics columnist at the FT and formerly a member of the UK’s Independent Banking Commission, sees to the core issue:
“banks, as presently constituted and managed, cannot be trusted to perform any publicly important function, against the perceived interests of their staff. Today’s banks represent the incarnation of profit-seeking behaviour taken to its logical limits, in which the only question asked by senior staff is not what is their duty or their responsibility, but what can they get away with.”
This matters because, “Trust is not an optional extra in banking, it is, as the salience of the word “credit” to this industry implies, of the essence.”
As the FT editorial put it, “The bankers involved have betrayed an important public trust – that of keeping an accurate public record of the key market rates that are used to value contracts worth trillions of dollars”.
In the words of Mervyn King, governor of the Bank of England, “the idea that my word is my Libor is dead.” Translation: No one will believe large banks again when their executives claim they could have borrowed at a particular interest rate – we will need to see actual transaction data, i.e., what they actually paid. Presumably there should be similar skepticism about other claims made by global megabanks, including whenever they plead that this or that financial reform – limiting their ability to take excessive risk and impose inordinate costs on society – will bring the economy to its knees. It is all special pleading of one or another, mostly intended to rip off customers or taxpayers or, ideally perhaps, both.
Mr. Kelleher has the economics exactly right. Global megabanks have an incentive to deceive customers, including both individuals and nonfinancial corporations. Their size confers both market power and the political power needed to conceal the extent to which they are engage in economic fraud. The lack of transparency in derivatives markets provides them with an opportunity to cheat, but the abuses are much wider – as the Libor scandal demonstrates.
The rip-off is not just for retail investors; chief financial officers of major corporations who should be up in arms. Boards of directors and shareholders of companies that buy services from big banks should be asking much harder questions about all kinds of derivatives transactions – and who exactly is served by the terms of such agreements.
As Mr. Kelleher puts it on his blog,
“They like to call themselves “banks,” but they aren’t banks in any traditional sense. They are global behemoths that are not just too-big-to-fail, but also too-big-to-regulate and too-big-to-manage. Take JP Morgan Chase for example. It has a $2.35 trillion balance sheet, more than 270,000 employees worldwide, thousands of legal entities, 554 subsidiaries and, as proved by the recent trading losses in London, a CEO, CFO and management team that has no idea what is going on in their own bank.”
“Let’s hope for the sake of the global financial system, the global economy and taxpayers worldwide that Mr. Diamond’s resignation is the first of many. What is needed is a clean sweep of the executive offices of these too-big-to-fail banks, which are still being governed by the same business model as before the crisis: do whatever they can get away with to get the biggest paychecks as possible. (Remember, CEO Diamond paid himself 20 million pounds last year and was the UK banking leader insisting that everyone stop picking on the banks.)
Lie-more is just the latest example of why that all has to change and the sooner the better”
An edited version of this post appeared on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.