Curious Capitalist

Banking’s Really Bad Day

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Four years on from the financial crisis, new banking scandals still seem to break out every few months. But this week has been particularly bad for the industry. There was HSBC’s $1.9 billion settlement with the U.S. Justice Department over laundering money for Latin American drug cartels and helping countries like Iran, Cuba, Sudan, Libya, and Burma avoid sanctions. Standard Chartered, another British bank, got dinged too, and now owes Justice a total of $667 million in fines for similar sanction breaches.

Then there were the arrests of three London bankers, including one who had worked at Swiss financial giant UBS, by London police as part of the ongoing investigation into widespread manipulation of “LIBOR,” or the “London Interbank Offered Rate,” which is the interest rate that a bank might charge one another bank to borrow money. UBS has reportedly put aside an extra $610 million this year to deal with regulatory issues, presumably in expectation of fines along the lines of the $450 million paid by Barclays for rate manipulation earlier this year.

(MORE: The Case for Banking Regulation)

Whew. It’s a lot to take in, and market officials are opening public coffers and doing just that — indeed, given the low-hanging fruit of scandal that still seems to exist in the banking industry, it may be that throwing more money at regulators who turn up further financial misdeeds could be a new way to plug the deficit.

But joking aside, not all these scandals are created equal. Standard Charter’s sanction offenses are specific to the politics of the U.S. HSBC’s money laundering is a bigger deal, and as Financial Times columnist John Gapper pointed out in a very smart blog post, raises the issue of the high reward/high risk ratio of doing business in emerging markets. Both HSBC and Standard Chartered have their roots in Asia, and have done well in boom times. But emerging markets are tougher to police than more regulated ones like Europe and the U.S. – and clearly, HSBC missed the boat. It’s also worth pointing out, as I did in a column earlier this year on Walmart’s bribery scandal in Mexico, that these sorts of risk issues in emerging markets aren’t finance specific.

The headline to really pay attention to, though it doesn’t yet have a firm dollar figure attached to it, is the one about UBS. If UBS if found to be at fault in the LIBOR case, it will be yet another domino to fall in the biggest scandal since the financial crisis, one that goes to the heart of trust in the global financial system. LIBOR isn’t just some wonky banking concept – it’s the rate to which $350 trillion worth of derivatives contracts and some $10 trillion worth of mortgage, educational, auto, and other loans are pegged. LIBOR doesn’t roll off the tongue as easily as “London whale” but it’s a much bigger deal than a single bad trade. “These rates are at the absolute core of our global financial system,” says Gary Gensler, head of the U.S. Commodity Futures Trading Commission, which has been at the forefront of LIBOR investigations over the last several years. If they are falsely reported, “that goes to the integrity of markets, and how much trust the public has in them.”

(MORE: LIBOR Scandal: The Crime of the Century?)

And as it turns out, public trust was indeed misplaced. On June 27, after four years of investigation by the CFTC, Barclays became the first major bank to publically admit that it had been manipulating its LIBOR rates for years. Over a dozen global banks are now under investigation by authorities on both sides of the Atlantic for falsely reporting or manipulating LIBOR rates. A number of those banks have been setting aside massive coffers to deal with potential fines. In short, it’s looking very likely that some of the people who have corrupted our financial system over the last several years are going to have to pay. It’s also looking more and more likely that the entire LIBOR system will be overhauled.

If it is, it will be largely down to Gensler, who has been leading the charge on LIBOR since he took over the CFTC in 2009. A year before, there had been hints that rates, which are based not on real lending transactions but “guesstimates” made by a panel of 20 global banks, might not reflect reality. LIBOR is a measure of banks’ trust in their solvency, and in 2008 that was declining, but rates weren’t rising, because if a bank revealed publically that it could borrow only at elevated rates, it would essentially be admitting that it — and perhaps the entire financial system — was vulnerable.

Authorities knew something was up. In 2008, Mervyn King, governor of the Bank of England, said about LIBOR, “It is in many ways the rate at which banks do NOT lend to each other.” Treasury secretary Tim Geithner had queried the math behind the calculations, but in the midst of the Lehman Brothers collapse and fallout, failed to press harder. What’s more, as experts like Sebastian Mallaby, director of the Maurice R. Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations, have pointed out, some public authorities may have been reluctant to draw attention to the problems for fear of causing further panic or problems in the markets.

But the CFTC, once it began looking, found plenty of damning evidence. “Dude, I owe you big time,” reads one email from a trader to a Barclays staffer involved in fixing rates. “I’m opening a bottle of Bollinger.” The champagne may not have cost consumers anything — indeed, to the extent that LIBOR rates were kept artificially low, it’s possible that people who had loans pegged to those rates benefitted, at least financially. But it illuminated a culture in which bankers routinely commit fraud, while regulators turn the other way. It’s a culture we’re still paying for.  And many financial institutions will be, too, for months and perhaps years to come.

MORE: How Fining Bad Banks Can Fix Our Biggest Money Problems