Crooking the LIBOR

The corrupt innkeeper Thenardier

In the song ‘Master of the House’  from the musical Les Miserables, the corrupt innkeeper Thenardier first denies he was like other innkeepers who ‘rook their guests’ and ‘crook their books’.   In due course, however, he confesses to similar sins:

‘Ready to relieve ’em of a sou or two
Watering the wine, making up the weight
Pickin’ up their knick-knacks when they can’t see straight’

Looks like Thenardier’s modern counterpart is Robert Diamond, former chief executive officer of the British Bank–Barclays PLC, who resigned in early July 2012 as Barclays got heavily embroiled in scandals alleging LIBOR manipulation.  Apparently, he had help from colleagues within the bank.

Robert Diamond, former Barclays CEO

LIBOR, or the London Inter-Bank Offered Rate, is an interest rate at which banks can borrow funds from other banks in the London inter-bank market. The LIBOR is fixed on a daily basis by the British Bankers’ Association. The LIBOR is derived from a filtered average of the world’s most credit-worthy banks’ inter-bank deposit rates for larger loans with maturities between overnight and one full year.    The highest and lowest rates are thrown and the middle rates are averaged.  

The LIBOR is the world’s most widely used benchmark for short-term interest rates. It’s important because it is the rate at which the world’s most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based. For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. 

Bank of England

Among the countries that rely on the LIBOR for a reference rate include the United States, Canada, Switzerland and the United Kingdom.

Investigated by American and British authorities, Barclays was fined $450 million in June 2012 for the rate fixing.  Barclays had supposedly submitted false rates to improve its earnings and deflect concerns about its financial health.  The rate manipulations happened between 2005 and 2009, as often as daily.  Diamond joined Barclays in 1996 and was a member of the bank’s executive committee in 1997 until his resignation.  

Questioned in the British Parliament, Diamond claimed he was unaware of the LIBOR manipulation up  until recently.   He however revealed discussions with Paul Tucker, deputy governor of the Bank of England.  Not a few parliamentarians expressed dissatisfaction with his testimony.

A story (http://dealbook.nytimes.com/2012/07/16/former-senior-barclays-executive-faces-scrutiny-in-parliament/) in the July 16 issue of the New York Times reveals damning details.

Former Barclays COO Jerry del Missier

In testimony before Parliament, Jerry del Missier, former Barclays chief operating officer,  indicated that he had received instructions from Diamond to lower the rates, after the chief’s discussions with bank regulators on the matter.

In 2008, Diamond sent Missier and another senior executive an e-mail regarding the government’s concerns about the bank’s Libor rate submissions.  Diamond also discussed the issue with Missier by phone. 

The e-mail detailed a conversation between Diamond and Paul Tucker, deputy governor of the Bank of England, the country’s central

Paul Tucker, Bank of England deputy governor

bank. The two men discussed the bank’s financial position at the height of the financial crisis. After receiving the e-mail,  Missier instructed Barclays officials on October 29, 2008, to lower the bank’s Libor submissions in line with those of rivals.

In his testimony, Missier said he had acted in response to the conversation with Diamond. He said he believed that senior government officials had instructed the bank to alter the rates. Missier, however, did not speak to anyone at the Bank of England or other senior regulators about the issue.

“I expected that the Bank of England’s views would be incorporated into our Libor submissions,” Missier said during his testimony. “The views would have resulted in lower submissions.”

On the other side of the Atlantic, evidence was also unearthed that all is not well with LIBOR setting.  A report submitted by the Federal Reserve Bank of New York to the US Congress reads as follows:

“Among the information gathered through markets monitoring in the fall of 2007 and early 2008, were indications of problems with the accuracy of LIBOR reporting. LIBOR is a benchmark interest rate set in London by the British Bankers Association (“BBA”) under the broad jurisdiction of the UK authorities, based on submissions by a panel of mostly non-US banks. The LIBOR panel banks self-report the rate at which they would be able to borrow funds in the interbank money market for various periods of time. As the interbank lending markets dried up these estimates became increasingly hypothetical.

Suggestions that some banks could be underreporting their LIBOR in order to avoid appearing weak were present in anecdotal reports and mass-distribution emails, including from Barclays, as well as in a December 2007 phone call with Barclays noting that reported “Libors” appeared unrealistically low”.

A story from CNN last July 4, 2012 (http://edition.cnn.com/2012/07/03/business/barclays-diamond-resigns/index.html) explains the public uproar over the scandal.

Ralph Silva

LIBOR affects how much interest ordinary people pay on everything from credit card debt to home mortgages and student loans.

Former investment banker Ralph Silva says that is why the scandal has caused such fury.

“If they’re manipulating Libor, what they’re basically doing is taking money out of the public’s pocket, because their mortgage rates change, because their interest rates change, their loans/credit cards change — or their pension income changes,” he said.

The same CNN story reports that at least seven other banks are under investigation on suspicion of rate-fixing, leading to speculation that Diamond could be the first of many executives to resign.

Financial regulators in London have not named the banks, but Deutsche Bank, Royal Bank of Scotland, Credit Suisse and UBS have acknowledged that they are under investigation.

Citigroup and JPMorgan Chase have also confirmed that they are under investigation.

Will the government regulators be spared from these investigations?  If not, which body should investigate to ensure impartiality?

Peter Gumbel of the Time magazine raises a lot of questions in his July 16 article:

“Thanks to the New York Federal Reserve, we now know that both the Fed and the Bank of England could see and were being told that something was awry with the London interbank offered rate (LIBOR) already in late 2007. Yet it was several months before any regulator began an official inquiry into alleged manipulation of this key money-market rate, which is used as the basis for trillions of dollars of financial transactions around the world — and there appears to have been no serious attempt made to stamp out the practice at the time.

That in turn begs the question: Why weren’t the first signs taken more seriously? Has there been a serious failure of regulation, or are there strong mitigating circumstances that could explain and justify the lack of resolute action?”

Read more: http://business.time.com/2012/07/16/libor-rigging-what-the-regulators-saw-but-didnt-shut-down/?xid=newsletter-daily#ixzz21FuqOx5Z

The political economy of gain-oriented crime

I am guilty of frequently neglecting this blog for long stretches, for various reasons.  Even if a lot of interesting events are happening around me (like the impeachment of Chief Justice Renato Corona or Scarborough Shoal or the new executive order on mining), I did not blog as often as expected.  I felt I did not have anything to add to the public discourse.

My professional responsibilities often get in the way.  I have to teach my students, mark their exams and papers, and compute their final grades.

I am also a family man.

There were many instances where my creative juices did not flow.  I did not want to settle with so-so pieces.  I don’t want to just write; I want to write well.

I feel guilty for this neglect because readers had kept faith even while I am inactive.

To make up, I will start a series of blog entries on the political economy of crime.

What is crime?

For punsters, ‘crime’ is what criminals do.  The pun ‘begs’ the question: who are the criminals?  It may be better to see crime as what or how a state defines it—usually through its penal code.  In this sense, crime is a state-defined concept.  

I presented the draft of this paper in Pattaya last May.  My friend Decha from Thailand challenged me to imagine crime without a state defining it.   The best I could come up with?  A crime is committed when one inflicts physical, psychological, and economic harm on another (or others).  But more on this later.

For acts defined by the state, we are interested particularly in a large family of crimes which produces material (and non-material) gain.  These gainful crimes are further classified into two ‘ideal types’: ‘white-collar crimes’[1] and and ‘violent crimes’ usually associated with criminal organizations like the Mafia, Yakuza, Medellin drug cartel in Colombia, and the Chinese triads. 

Colombian soldiers and corpse of Pablo Escobar, boss of Medellin drug cartel

Yakuza gang members

For this reason, crimes of passion and other crimes that do not produce economic gain for the criminal are excluded from our analysis.  A crime passionel is usually committed by an individual (or possibly a few persons), does not require an organization much less a transnational one, and does not (usually) require premeditation.

 

Blue-collar worker

 

In American English, ‘blue-collars’ are workers supplying manual labor in factories and the streets while ‘white-collars’ principally used their brains to work in offices.  Office workers (predominantly males at the time) dressed appropriately with a coat and the obligatory white shirt (with detachable white collars) plus tie.  White-collar workers steal and (on occasion) kill but they use guile and deception rather than threats and direct violence.  Lacking the presumed  ‘legality’ of white-collar criminals, violent criminals threaten or use force ‘earn’ illicit gains.  This is illustrated by the difference between a book-keeper who ‘cooks’ office accounts to skim off money and the street hood snatching a gold watch from a pedestrian.   The U.S. Congress defined white-collar crime as an illegal act or series of illegal acts committed by non-physical means and by concealment or guile, to obtain money or property, or to obtain business or personal advantage.

Modern version of detachable white collar

The idealized distinction between white-collar crime and ‘violent crime’ is simply that—an idealized one.  In reality, white-collar criminals may also threaten and use violence themselves or may employ strong-men to achieve their objectives.  And so-called ‘violent’ criminals can also deceive, dissemble, and use guile.  An example is the thief who slashes your bag or picks your pocket without you knowing it you are both in a bus or other means of public transport. In short, guile, deception, dissembling, threats, and direct violence are all in the criminal repertoire.

 It is hypothesized that as the scale of criminal operations increases, criminal organizations will have need for ‘front’ offices with white-collars and ‘back-room operations’ carried out by strongmen.  The criminal organization becomes a two-faced and a more complex one.

A special kind of white-collar crime is corporate crime which is criminal activity on behalf of a business organization.  They include crimes of fraud, concealment, and misrepresentation that continue to victimize all sorts of groups and individuals in society.  Corporate crime operations are not usually conducted by atomized individuals.  Corporate crime involve organizations especially when operations become transnational.  The skillful concealment of debts and losses by Enron’s executives led to the company’s bankruptcy, the dissolution of Arthur Andersen (at the time one of five largest accountancy partnerships in the world), loss of billions in dollars in pensions and stock prices sustained by employees and shareholders (not only in the US), and caused a crisis in confidence.  The event was reprised a year earlier with Worldcom with bigger losses.  While no criminal proceedings were initiated against Worldcom executives, many Enron executives were indicted for a variety of charges and sent to prison.

However, the jury is still apparently out if the massive sale of financial derivatives that led to the financial crises of 2007-2008 in the United States constitutes criminal fraud.  Picture this.  These new-fangled financial instruments were an amalgam of good and risky home mortgages.  This practice supposedly made good business sense since housing prices had been going up for quite a time.  As new instruments, the derivatives are sold in tranches—the good, the not so good, and the don’t bother.  These tranches are rated either by Moodys, Standard & Poor, or Fitch and the first tranche would rate AAA, the second BBB, and the ‘don’t bother’ may not be sold at all.  Since the last tranche is risky and will thus earn higher returns, the seller keeps them on its balance sheet.  Fraud is first committed by the seller’s non-disclosure of the risk surrounding such instruments to investors.  In fact, they actively promote the same as risk-free instruments.  However, sellers protect themselves against risk by buying insurance—again without informing the investors. 

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[1] The term white-collar crime was coined in the 1930s by Edwin Sutherland who defined it as crime committed by a person of respectability and high social status in the course of his occupation.