JOURNAL: The Market Has Spoken, and It Is Rigged By SIMON JOHNSON

The Market Has Spoken, and It Is Rigged



By SIMON JOHNSON

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at

the M.I.T. Sloan School of Management and co-author of "White House

Burning: The Founding Fathers, Our National Debt, and Why It Matters

to You."



In the aftermath of the Barclays rate-fixing scandal, the most

surprising reaction has been from people in the financial sector who

fully understand the awfulness of what has happened. Rather than

seeing this as an issue of law and order, some well-informed people

have been drawn toward arguments that excuse or justify the behavior

of the Barclays employees.



This is a big mistake, in terms of the economics at stake and the

likely political impact.



The behavior at Barclays has all the hallmarks of fraud - intentional

deception for personal gain, causing significant damage to others.



The Commodity Futures Trading Commission nailed the detailed mechanics

of this deception in plain English in its Order Instituting

Proceedings (which is also a settlement and series of admissions by

Barclays). Most of the compelling quotes from traders involved in this

scandal come from the commission's order, but too few commentators

seem to have read the full document. Please look at it now, if you

have not done so already.



The commission's order portrays a wide-ranging conspiracy (or perhaps

a set of conspiracies) to rig markets, including, but not limited to,

any securities for which the price is linked to a particular set of

short-term interest rates.



The collective term for these rates is the London Interbank Offered

Rate, known as Libor, but the use of this nomenclature sometimes hides

the fact that there is a separate Libor daily for each of 10

currencies at 15 maturities, from overnight to 12 months, according to

the British Bankers Association. The notional size of the derivatives

involved is on the order of $360 trillion.



Barclays could not have manipulated those rates by themselves - and

that is not what the C.F.T.C. found or the basis of the Barclays

settlement. Rather, some Barclays employees colluded with people at

other banks in a way that, over a period of years, moved Libor rates

up and down, depending on what would favor the trading positions of

the people and organizations involved.



Each Libor "panel" of banks involves seven to 18 banks. Participating

banks submit the rate at which they can supposedly borrow at a

particular maturity and in a specified currency, and an average is

calculated (taking out high and low values). No one bank is likely to

be able to move the calculated Libor rates by itself.



Once the global financial crisis began to bite, there appears to have

been a more systematic manipulation of Libor reporting by Barclays

management in a particular direction - downward, to make it seem that

the bank was healthier and therefore able to borrow from other banks

at a cheaper rate.



George Osborne, Britain's chancellor of the Exchequer (the equivalent

position to the secretary of the Treasury) and a Conservative Party

member, said recently, "Fraud is a crime in ordinary business; why

shouldn't it be so in banking?" The answer, of course, is that fraud

is not allowed in any well-run country.



Anyone who takes personal responsibility seriously should want all

those involved to be held accountable - to the full extent of the law

in all jurisdictions. Anything that lets individuals escape

consequences will further undermine the legitimacy that underpins all

markets. Bankers should be leading the charge to clean up their

industry.



Nevertheless, five arguments put forward in the last 10 days, singly

or collectively, attempt to provide some sort of cover for what

happened at Barclays. None of these arguments have any merit.



First, it is argued that this kind of cheating around Libor has been

going on for a long time. This may be true, but it is a sad and lame

excuse that is unlikely to get anyone off. The bigger question must

be: Is the financial sector crooked at its core? Statements about a

pattern of behavior only strengthen the case that incentives, culture

and organizations are all badly broken at the heart of the world's

financial system.



Second, it is also asserted that "everyone does it." This is not any

kind of defense - try it next time you are accused of fraud. But the

perception that many people could be involved is part of the reason

why this scandal has legs. A broad range of involvement across the

financial sector is consistent with what is in the C.F.T.C. order -

although the full scope of the conspiracies has not yet been made

clear.



There are three United States banks involved in Libor panels: JPMorgan

Chase, Bank of America and Citigroup. Are they also implicated in some

aspect of rigging interest rates and therefore securities prices?



Barclays was the first to settle with the C.F.T.C., presumably

enabling investigators to gain better access to information about who

else is involved. It would not be a surprise if bigger fish are still

to come.



Third, Libor-rigging is defended as a "victimless crime." This is

untrue. Traders at Barclays and other banks gained from this series of

manipulations, so someone else lost. That may have been investors, who

received lower returns than they would have otherwise. Or it may have

been borrowers, who paid higher interest rate and related costs than

would have been necessary in an honest market. Other losers are

presumably everyone who was effectively overcharged by all the

intermediaries involved in crooked behavior. Some local governments

have also lost heavily, at a time when these losses put pressure on

essential services and will tend to increase taxes.



Honest people in the financial sector should be up in arms about the

behavior of Barclays and other megabanks.



Fourth, some contend that it is the regulators' responsibility and

fault that there was cheating on Libor. It is certainly the case that

there was regulatory capture at work -- that is, officials in Britain,

the United States and perhaps elsewhere should have been paying closer

attention. I made exactly this point on National Public Radio's "All

Things Considered" last Saturday.



The mystique of the financial sector wowed many people - including

many prominent policy intellectuals, Democratic and Republican - in

the years before 2008. But who does the capturing in regulatory

capture? Big banks work long and hard and lobby at many levels to push

regulators toward paying less attention.



Fifth, the weakest argument is, "It was only a few basis points, here

and there" (where a basis point is a hundredth of a percentage point,

i.e., 0.01 percent). Either the Libor reporting process and,

consequently, the pricing of derivatives has been corrupted by a

criminal conspiracy, or it has not. There is no "just a little" in

this context for the enormous global securities market.



Robert E. Diamond Jr., who resigned last week as chief executive of

Barclays, reportedly said, "On the majority of days, no requests were

made at all" to cheat on Libor. The Economist, which does not make a

general habit of criticizing prominent people in the financial sector,

observed, "This was rather like an adulterer saying that he was

faithful on most days."



Mr. Diamond has fallen. Who is next? How will this play in American

politics? There is still time for politicians on the right and on the

left of the political spectrum to get ahead of the issue. Digging in

around specious arguments in favor of price-fixing cartels is not the

way to go.



Power corrupts, and financial market power has completely corrupted

financial markets. Barclays and the other global megabanks involved in

fixing Libor have brought their own industry very low - completely

destroying the legitimacy on which sensible financial intermediation

needs to be based.



Who trusts a banker at this point? The collateral damage is enormous.

Who in their right mind would buy a complex derivative product from

Barclays or anyone else implicated in this growing scandal?