July 5, 2012
While cities and communities across the United States prepared for fireworks displays to celebrate the Fourth of July, in London the only fireworks on view took place during the hearing held by a British parliamentary committee into the apparent manipulation of London's famed benchmark interbank lending rate, LIBOR. And in the hot seat was Bob Diamond, who joined Barclays investment bank exactly 16 years earlier, on the Fourth of July – and who had resigned just the day before as its CEO, citing "external pressure."
Liborgate, as it is becoming known, is yet another black mark for the financial services industry. This time around its center is in the City, the heart of London's financial industry, rather than Wall Street –- but the issues at the core of the scandal, and the questions that are left for policymakers and other observers to debate remain almost identical to those raised in the wake of the financial crisis. Is there anything that a bank or investment bank will not do in order to maximize its profits? Is there any figure within the industry worthy of the public’s trust? Are all financial leaders, in the words of one of Diamond's questioners yesterday, either incompetent or complacent?
WHAT IS LIBOR?
The scandal revolves around LIBOR, the rate that banks use when lending to each other. The rate is set as an average of rates that banks are charged, with each bank reporting its own funding rate. The LIBOR rate in turn affects other rates, including those for consumer loans. Regulators found evidence dating as far back as 2005 that Barclays manipulated the rate for its own benefit, and regulators are looking into whether other banks did the same.
Much of the alleged misconduct took place during the financial crisis that began in September 2007. According to the final report by British regulators (who, along with U.S. authorities, levied a massive fine of about $450 million on the bank), Barclays was seen by the media as having higher "LIBOR submissions" – in plain English, the rate at which it could obtain funds was perceived as being relatively higher, a possible signal on the part of its lenders that they worried about the bank's liquidity. "Senior management at high levels within Barclays expressed concerns over this negative publicity," the report states – and the bank began submitting artificially low reports. The LIBOR rate then began to fall.
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In Britain, the scandal has immense repercussions for the City and odds are that there will be some political fallout as well. If other banks were doing the same thing – as Barclays clearly believes – then the LIBOR rate, which still shapes the rate on trillions of dollars' worth of financial transactions ranging from mortgages to complex derivatives transactions may not reflect anything real, other than the real desire of bank managers for their institutions to appear more robust and creditworthy than they were. To the extent that the BBC is correct in attributing Barclays' actions to a conversation between a top Bank of England manager (Paul Tucker, currently tipped to inherit Sir Mervyn King's post as head of the central bank) and Diamond, the independence and integrity of the central bank could be at stake as well – to a degree that those who lambaste the Federal Reserve can only begin to imagine.
Until this year, only Diamond and Jamie Dimon, CEO of JPMorgan Chase, had emerged with reputations enhanced by the financial crisis. That gave both men a bully pulpit of sorts, which both used to defend their own institutions but also to try to shield their industry from what they viewed as intrusive regulations. In quick succession, events have demonstrated not only that their halos are tarnished, but probably were crafted from kind of base metal in the first place.
THE ROLE OF BIG BANKS
The financial crisis changed the role that financial institutions can and should play in both society and in the political sphere. Initially, Diamond appeared to realize that, calling last winter for a new way of thinking on the part of banks; that they should "serve a social purpose and meet a real client need." While it's possible that Diamond – to the extent that he personally was aware of the LIBOR-rigging scandal and complicit in it – rationalized the actions of his employees at the time as helping to keep the bank afloat during the crisis, and preventing the kind of liquidity crisis that had caused the demise of Lehman Brothers, Bear Stearns and forced the fire sale of Merrill Lynch. After all, if the bank wasn't extant, how could it serve its clients and any "social purpose"? But to the extent that was the rationale driving Diamond or his underlings, it's the kind of sophistry that causes rational thinkers to wrinkle their noses in distaste.
The unpalatable message of the crisis and Diamond's actions – or inaction – is that financial institutions can't be trusted to not act foolishly in pursuit of their own self interest, and that the only question is how frequently they do so and how grave the consequences prove to be either for their shareholders or for the financial system as a whole.
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Bob Diamond escaped relatively unscathed from yesterday's hearing, and he'll walk away from Barclays – an organization that he took to the premier league of global banking – with a massive payoff, estimated in some reports to be as high as £30 million.
But while much of the fuss and attention focuses on what happened – on the past – surely it's long past time for us to shift our attention to what should happen next – to the future. What kind of leader will step into the shoes of Bob Diamond? And, in time, take over the helm of Goldman Sachs from Lloyd Blankfein or that of JPMorgan Chase from Jamie Dimon? Will they be people cut in the same mold, or will they be the kind of people who will ensure that they never have to find themselves in front of this kind of committee for this kind of reason, expressing their contrition and revulsion?