Dangerous Deals

July 18, 2012

First blood was drawn in the LIBOR scandal by the UK Financial Services Authority (FSA) when it extracted £290 million ($439 million) from Barclays, one out of a cabal of twelve international banks that allegedly conspired to lower the interest rate reflected in the LIBOR, otherwise known as the London Interbank Offered Rate.  Manipulating the LIBOR would allow banks to profit at the expense of ordinary investors, pension funds, and mortgage holders.

Some have praised Barclays for fessing up to its wrongdoing. I don’t hold that view. I believe that no bank would plead guilty because it has a troubled conscience. Rather, I would imagine that they have done a hardheaded assessment of the case against them and have seen that the evidence was strong. The other calculation that would have presumably gone into its decision was the damage to its reputation had the matter been dragged through the courts. These days reputation can be quantified, and the bank’s good name comes at a high price, which is likely to be much more than the fine it paid.

It should be noted at this stage that no charges have been laid against any bank, and it remains unclear whether other sweetheart deals are being negotiated. There are, however, a number of problems with doing deals behind closed doors.

The first and most obvious reason is that a bank will only agree to fines that are less expensive and less damaging to its reputation than what the bill would become should the matter go to trial. Unfortunately, the regulator also has rather tawdry reasons for doing a deal beforehand. Banks employ high-priced lawyers who will tie up the case for years as they drown the main issues in financial minutiae. Moreover, regulators seldom possess the budgets to employ their own high-priced lawyers for any period of time. Under-resourced by governments, regulators often have little choice to do deals, even when it is not in the best interests of the public.

But other reasons exist why regulators may welcome backroom deals. In the case of the FSA, allegations have been made that it turned a blind eye to the manipulations of the LIBOR, which could come out in court. In addition, it could reflect badly on other veritable financial institutions, damaging the reputation of the City as a banking hub. For example, reports circulated around October 2008 that senior Bank of England official Paul Tucker contacted Barclays to discuss why it was submitting such high borrowing rates to the LIBOR panel when other banks submitted much lower estimates. Could this have acted as a nod or even a wink to Barclays that low-balling its interest rates was okay? What other embarrassments might be brought out in open court?

Since 1986, London’s adoption of a “light touch” to regulations meant that where possible wrongdoing is going on, chaps would simply have a quiet word to the chaps doing the wrong thing, and no one outside the rarified hallways of the City would be the wiser. Heaven knows what the chaps said to one another during the LIBOR scandal, but obviously the “light touch” didn’t work. And I’m being kind.

While no evidence of the cover-up exists, a court case might well expose exactly what chit-chats the chaps in the City had about the LIBOR. That won’t happen, of course, if backroom deals are able to suppress such embarrassing evidence, if it arises.

There is another reason why regulators need to test these matters in open court. In backroom deals, they presumably commit to not release damning evidence into the public domain, which is understandable since it has not been tested in court. The suppression of such evidence, however, means that the public is not in a position to judge whether the fines are punitive, or, as many suspect, dwarfed by the profits made through the manipulation of the LIBOR. In addition, those who feel ripped off by the bank are denied potentially useful evidence should they decide to take civil action.

In the midst of all the talks of damages and fines, we should not forget that the allegations suggest that banks conspired to steal millions, possibly billions from ordinary people.  Justice demands that, if such evidence exists, that quite a few bankers do jail time. But we may never find out once agreed-upon statements of the facts are attached to out-of-court settlements, like the one entered into by Barclays.

In the US, where regulators are even more jelly-backboned than in the UK, I expect that wherever fines are extracted, the banks will do so, provided that there are no criminal convictions recorded and they are not required to admit guilt.

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  • Phil

    You’re right on. Even after the gfc we see JP Morgan speculating, loosing $6 billion, and a whole bunch of banks manipulating the LIBOR. The only solution is to give these guys some jail time so they know that there are consequences when they gamble with other people’s money.

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