Anarchy in the financial markets!

 If regulators don't fix the lawlessness in international financial markets, future losses might us all in

THE lawlessness that pervades the international banking industry and especially the large Western banks must raise serious questions as to what perpetuates such barbarous behaviour among the custodians of people's money.

A big part of it is that the banking industry operates on greed rewarding its key employees via commissions for businesses brought in, deals made, and products sold even if they were dubious in the first place.

This encourages among the industry a bunch of highly dishonest salesman who shield themselves behind a veil of professionalism to dupe and seduce customers into believing their products are good and their processes are strong, secure and fair.

And they are aided by ineffectual regulators who parrot the trite phrase that free markets should not be overly regulated but turn a blind eye when the biggest financial institutions amass massive positions to fix markets and deceive customers, making a mockery of market freedom.

The Angel of Independence monument stands in front of HSBC’s headquarters in Mexico City. Europe’s biggest bank has been found laundering billion of dollars for drug cartels, terrorists and socalled pariah states, in a scandal which almost overshadows the Barclays’ one. — Reuters

The integrity of free markets was compromised because big players could affect the direction of markets, making the markets way less than perfect. Free markets basically became unfettered freedom to make money even at the expense of the market and the potential collapse of the world's financial system.

They did it yet again or to be more accurate they did it earlier but their misdeeds surfaced once more recently. UK's Barclay's bank made a US$453mil settlement with regulatory authorities in the United Kingdom and the United States for fixing the London interbank offered rate (Libor).

Now, it turns out that Barclay's may not be the only one. According to a Reuter's report, other major banks are likely to be involved and may try and go for a group settlement with regulators, the US' Commodities Futures Trading Commission and the UK's Financial Services Authority.

The banks being investigated include top names such as Citigroup, HSBC, Deutsche Bank and JPMorgan Chase. They all declined to comment to Reuters.

And one of these banks, Europe's biggest HSBC, has been found laundering billion of dollars for drug cartels, terrorists and so-called pariah states, in a scandal which almost overshadows the Barclays' one. That leads to the question of whether other banks were involved as well.

If they jointly fixed the Libor, the world's most used reference rate for borrowings and derivatives with an estimated US$550 trillion, yes trillion, of assets and derivatives tied to the rate, it will be a scandal of epic proportions and may result in settlements of an estimated US$20bil-US$40bil.

That settlement will only scratch the surface. Just 0.1% of US$550 trillion is US$550bil. That implies that if banks had been able to fraudulently fix Libor so that it was just 0.1 percentage points higher, customers throughout the world would have had to pay US$550bil more in interest charges in a year.

In March this year, five US banks, including Bank of America, Citigroup and JP Morgan Chase, made a landmark US$25bil settlement with the US government for foreclosure abuses.

Even so, only a small fraction of affected house buyers are expected to benefit from this. Many other banks, however, are relatively unaffected and have not been fully called to account for their role in the US subprime crisis, which could have caused a collapse of the world's financial system.

Banks which bundled together risky housing loans into credit derivative products and passed them off as those with higher credit rating than their individual ratings, aided by ratings agencies, got off scot free. No one was called to account.

That the financial system is still vulnerable and that all gaps have still not been closed is JP Morgan's recent loss of up to US$4bil from rogue trading by a London trader going by the name of The Whale.

There needs to be a new set of rules, regulations and behaviour one based on ethics, honesty, competency and checks and balances. Custodians of public money should be required to be above all else honest first and foremost.

They should be consummate professionals whose first duty should be to protect the deposits of customers and the bank's capital. They should not do anything which puts the bank at undue risk.

The insidious habit of rewarding those who bring in revenue with hefty commissions have to be stopped so that bankers do not take risks which put their banks at undue risk which will eventually require trillion of dollars in rescue from governments.

Regulators should again make clear demarcations between those financial institutions who are custodians of public money and those who are not and hold the former to much higher standards of accountability and integrity.

Shareholders of financial institutions who are custodians of public money should be led to expect a lower rate of return on their investments but they should also be led to expect a lower corresponding rate of risk befitting that of major institutions which are so vital for the proper functioning of the economy.

Enforcers should focus on bringing individuals responsible for these losses to book and throwing criminal charges at them which will put them behind bars for long periods of time, befitting their severity. Society at large tends to treat white-collar criminals with kid gloves.

When derivatives trading and deception brought major Wall Street firms such as Enron and WorldCom to their knees and eventual collapse in the early 2000s, enforcers brought to book key executives who are spending time behind bars.

But despite the near collapse of the world's financial system, despite fraudulent behaviour, despite misrepresentation and deception, despite selling structured products of dubious value and then promptly taking positions against them, despite fixing of reference interest rates, despite money laundering and despite many other crimes still to be unearthed, no one has been brought to account.

Fining institutions leaves those individuals responsible free. In fact, settlements made come with the agreement that there will be no prosecution of individual bank staff and gives major incentive for others to do the same.

They are safe in the belief that the institution will pay the price and they will go free in the event things turn wrong. Otherwise, they will end up millionaires and even billionaires. How convenient an arrangement!

There is anarchy in the financial markets and a state of lawlessness which encourages heists of unimaginable proportions without risk of punishment. If we don't watch it, the losses will do the world economy, and all of us, in.

A Question of Business
By P. GUNASEGARAM

> Independent consultant and writer P. Gunasegaram (t.p.guna@gmail.com) is amazed that people can get away with so much by just repeating two words: free markets.

Related posts:
Libor scandal blows to British banking system
HSBC exposed: Drug money banking, terror dealings, money laundering!
Four British banks to pay for scandal!
Moody's downgrades 15 major banks: Citigroup, HSBC ...
British rivate banks have failed - need a public solution
Stop the banks from gambling!
Malaysian banks to curb the online scams - Rightways - Yes
Malaysian banks tighten the screening of loans
Banks tighten lending rules amid uncertainty

Libor scandal blows to British banking system

The still-developing Libor scandal is the latest and biggest blow to the credibility of big banks and their regulators, and should catalyse wide-ranging reforms to the financial system.

THE reputation and credibility of banks, regulators and the banking system in Western developed countries, already battered by the twists and turns of the financial crises, have reached new lows with the Libor scandal, which is still evolving and will yet reveal more wrong-doing. Blow ... Barclays >>

Besides Barclays Bank, which has paid US$456bil (RM1.45 trillion) in penalties to the British and US authorities, at least another 11 banks that were part of the rigging of Libor face up to US$22bil (almost RM70bil) in penalties and damages to investors and counterparties, according to an article in The Financial Times.

This is likely to be an underestimate because in addition, they may also face fines of billions of dollars or euros from anti-cartel actions. And more than the 12 banks that are publicly named are involved.

The Libor scandal could not have come at a worse time because the banking sector is already mired in many deep crises.

That the biggest banks in the world have been manipulating the revered Libor rates, which the public for so many years considered something that is set objectively and scientifically, is almost unimaginable.

The manipulations were reportedly of two types: to influence Libor rates so that the bank could make profits in its derivatives trades, and to dishonestly portray that its own borrowing costs were lower than what they were, so as to raise the bank’s image.

The scandal hits at the heart of the global banking business, because Libor (the London Interbank Offered Rate), is the benchmark relied upon for many thousands of contracts in the financial world.

This new hit to the banks’ credibility comes at a time when there are new signs of a serious downturn in the global economy.

In particular, the growth rates of many major developing countries have declined significantly in the last three months, signifying that the banking and debt crises in Europe are beginning to have a serious impact on the developing world.

The Libor scandal may contribute to the deteriorating world economic situation.

At the least, the banks involved in the scandal may have a worsened financial position, with less credit to provide to the real economy.

The estimated fines would cut 0.5% off their book value, and each bank may also have to pay an average of US$400mil (RM1.27bil) because of lawsuits, according to a study by Stanley Morgan, as reported in The Financial Times.

This may only be the tip of the iceberg. Regulators in many countries, other than Britain and the United States, are investigating, including Canada, Japan, and Switzerland, while many corporations and lawyers are considering lawsuits against the banks. The credibility of the European and US regulators have also been affected.

Either they did not know about the manipulations of the banks and were thus not doing their job, or they knew about it and allowed the deception to continue for years.

Manipulation in the Libor system was apparently known, at least in the trade, by 2005.

In April 2008, an article in Wall Street Journal raised questions about the way Libor was set.

Last week (on July 13), documents released by the New York Federal Reserve showed that US officials had evidence from April 2008 that Barclays was knowingly posting false reports about the rate at which it could borrow, according to several news reports, including in the Wall Street Journal.

A Barclays employee told a New York Fed analyst on April 11, 2008: “So we know that we’re not posting, um, an honest Libor.”

He said Barclays started under-reporting Libor because graphs showing the relatively high rates at which the bank had to borrow attracted “unwanted attention” and the “share price went down”.

The Fed analyst’s information and concerns were passed on to Tim Geithner, then head of the New York Fed.

In June 2008, Geithner sent a memo to the Governor of the Bank of England, with six proposals to ensure the integrity of Libor, including a call to “eliminate incentive to misreport” by banks.

The documents show that the US authorities knew about irregularities in the Libor interest-rate market and had discussed the need for reforms with the British authorities as far back as mid-2008.

The question being asked is why the regulators did not act until this year.

The Libor scandal may be, or should be, the final straw that forces the developed countries’ political leaders and financial authorities to undertake a thorough and systemic reform.

The financial system has been plagued by one crisis and scandal after another, and of crisis responses.

There needs to be reform of the regulatory framework and enforcement, the hugely excessive leveraging allowed by financial institutions, the laws that permit a combination of commercial banking and proprietary trading in the same institution, the speculative and manipulative activities and instruments of financial institutions, fraudulent practices and the incentive system, including unjustified high pay and bonuses and high rewards to bankers for speculation-based earnings.

A reform of the Libor system or establishing an alternative to it is of course also required.

In the Libor system, a panel of banks will set the borrowing rates for 10 currencies at 15 different maturity periods.

Two types of manipulation emerged in the Barclays case.

The first involved derivatives traders at Barclays and several banks trying to influence the final Libor rate to increase profits (or reduce losses) on their derivative exposures.

The second manipulation involved submissions by Barclays and other banks of estimates of their borrowing costs which were lower than what was actually the case.

Almost all the banks in the Libor panels were submitting rates that may have been 30-40 basis points too low on average, according to The Economist.

GLOBAL TRENDS By MARTIN KHOR newsdesk@thestar.com.my

Related posts:
Four British banks to pay for scandal! 
British rivate banks have failed - need a public solution 
After Barclays, the golden age of finance is dead 
UK Banking Rules Risk Bank's Future Market Value 
RBS, biggest British stated-owned bank losses of £3.5bn ! 
Cost of bank bailout keeps rising for UK