Update | Link below for CNBC "Closing Bell" ~ 3:30 ET to talk about the continuing crisis. Chris
What do the rogue hedge fund inside JPMorgan Chase and the LIBOR price-fixing scandal engulfing Barclays Bank have in common? Many things, but first and foremost they illustrate the impunity and recklessness of large corporations. Once safely inside the warm cocoon of a management position in a public stock corporation, normal people become masters of the universe and it’s all bad from there. Think Tilda Swinton in the Tony Gilroy film Michael Clayton.
The first thing to say about both scandals involves operational risk and management indifference to investor interests. As former SEC head Arthur Levitt told Tom Keene on Bloomberg Radio, no bank CEO can possibly know what is going on inside these gigantic enterprises. Even if the management of a large bank or non-bank stock corporation wants to do the right thing, admittedly a silly assumption, it is very difficult to embed good action in the organizational culture.
A colleague asked me today why large banks periodically burn through vast piles of investor money. In the classic 1932 book “The Modern Corporation and Private Property,” by Adolf Augustus Berle and Gardiner Coit Means, the authors describe how stock corporations (as opposed to mutual organizations devoted to the service of their members) often diverge from the interests of their investors.
Berle and Means note most tellingly that stockholders have traded the position of owner for that of recipient of investment returns. Comparing the position of the modern day investor to feudal times, the authors noted:
“The independent worker who entered the factory became a wage laborer surrendering the direction of his labor to his industrial master. The property owner who invests in a modern corporation so far surrenders his wealth to those in control of the corporation that he has exchanged the position of independent owner for one in which he may become merely recipient of the wages of capital.”
Thus when we hear people talking about “accountability” when it comes to large public banks like JPMorgan and Barclays, we know that those speaking just do not get the joke. Of note, the directors of a US public company organized under the equally feudal laws of the State of Delaware have a duty of care to the corporation, not to shareholders. So when JPM CEO Jaimie Dimon lost a ton of money at the derivatives crap table this year, the bank’s directors are under no pressure to fire him.
The regulators are likewise complicit in the theft since the managers of the large banks are seen as clients. Expecting regulators to prevent the periodic operational blowup at a too-big-to-fail bank is like asking the fire department to spray gasoline on a fire. Only when the public, reputational risk to a big bank becomes critical, as in the case of Barclays, does the CEO walk the proverbial plank. Merely losing a lot of shareholder money is not sufficient cause for execution.
But the other thing that needs to be examined in this banking industry fire storm is the question of market manipulation. Bob Eisenbeis of Cumberland Advisors (www.cumber.com) notes: “[T]here is the implication that the falsification of LIBOR rates was not only being practiced by Barclays but also by other institutions. “ He also notes the reports in the media that there was pressure from certain institutional investors for months to “adjust” LIBOR lower.
The first point to make about LIBOR is that this has never been a particularly transparent, market rate. The LIBOR rate has always reflected the consensus indications of the participating banks. Over the decades, many investors and parties in business agreements have used the LIBOR rate as a means of pricing risk. This does not excuse the actions of Barclays and others, but it needs to be said that LIBOR is not a free market rate set via competitive price discovery. Investors with long exposure to LIBOR surprised by all of this ought to wake up and smell the coffee.
The second, related point is the market environment for LIBOR. Given the degree of market manipulation by global central banks and finance agencies over the past two decades, getting into a heated argument about private banks manipulating market rates seems a little surreal. Commercial banks are also used by governments as mechanisms for official market manipulation, thus begging the question again as to whether the actions of Barclays in manipulating LIBOR are really so remarkable.
In a market where the fact of government manipulation is the rule rather than the exception, how can we get overly worked up about Barclays manipulating LIBOR or JPMorgan manipulating the entire market for credit derivatives? Reading the Big Media you might think that the world is about to end. AP reports:
“Two leading credit rating agencies took steps Thursday toward downgrading Barclays in the wake of a trading scandal that's seen three senior Barclays executives, including CEO Bob Diamond, hand in their resignations.”
Once again, Moody’s and S&P are shown to be trailing indicators of asset allocation change points. But what has really happened in the Barclays mess is that the tawdry reality of the banking world has run smack dab into the nasty political environment in the UK. While professionals in the financial markets have for decades known that LIBOR was at best an indication of where the London clearing banks might be willing to lend money, politicians have jumped on the opportunity to berate the bankers in a loud voice.
But so what?
The real proof of whether the Barclays scandal causes real change will be if we move to a LIBOR rate that is a function of actual trades. The UK clearing banks could aggregate all LIBOR transactions and report a public high, low and average for each trading day. That simple solution could turn LIBOR from an opinion into an indicator of market rates.
But the key question is whether the politicians yelling at the banks today will take steps tomorrow to affect real change in the collusive behavior of the same large banks. The politicians are the "wage slaves" of the big banks, right? Just as in the market for OTC derivatives, the largest banks prefer not to report actual trades in the short-term money markets. We need to gather data for every trade every day, IMHO, and negotiate terms for public reporting of that data to make LIBOR a real market rate.
My friend George Washington is right when he calls the LIBOR scandal “The Biggest Financial Scam In World History,” but this is banking we are talking about, right? Please do be angry and hold that thought a long while. But please don’t tell me that you are surprised that Barclays was “manipulating” LIBOR.