
The rotten heart of finance - bcn
http://www.economist.com/node/21558281?fsrc=scn/tw_ec/the_rotten_heart_of_finance
======
cletus
I read things like this and by fixing LIBOR they're treating a symptom rather
than addressing the cause.

My belief--and many seem to disagree with me on this whenever I've brought it
up before--is that we erred in allowing investment banks to incorporate.

IMHO investment banks need to act like law firms: as partnerships with
_unlimited_ liability. Currently there is no incentive to not pervert the
system and manage risk because:

\- no one is going to jail for criminal acts committed in these financial
crises (eg loan documentation fraud and illegal foreclosings in the subprime
fallout);

\- there is no financial incentive to act responsibly because if you go
bankrupt this year last year's bonus is already banked;

\- central banks have been perverted into being welfare for investment bankers
as a so-called "lender of last resort". Ostensibly they are ensuring the
function of the financial system. In practice they are giving investment banks
an unhealthy appetite for risk. Banks and funds need to be allowed to fail;
and

\- governments are complicit in this.

~~~
rayiner
I agree with you. The partnership structure forces law firms to be run very
conservatively, and prevents them from scaling to huge sizes, which has the
advantage of limiting the amount of consolidation in the industry. I think for
professions like banking, law, and accounting, these are good incentives.

I think it would also help to take more seriously the ethical responsibilities
of bankers as fiduciaries' for peoples' money. A law firm cannot represent
both sides of a merger, because that would involve a conflict of interest. So
why can Goldman take positions where they stand to profit enormously if their
clients lose money?

~~~
twoodfin
_So why can Goldman take positions where they stand to profit enormously if
their clients lose money?_

Because Goldman's clients are grown-ups and allowed to have their own beliefs
about the future of the market, as well as their own risk tolerance.

Goldman wasn't obligated to put up a shingle reading "We are losing our
appetite for CDOs, and so can't take your money if you think they're still a
great investment."

~~~
forensic
>Goldman wasn't obligated to put up a shingle reading "We are losing our
appetite for CDOs, and so can't take your money if you think they're still a
great investment."

This is the problem. They should be obligated. Being a professional carries
ethical constraints. If your clients aren't getting your best advice you
aren't a professional, you are a salesman. It's not okay for salesmen to pose
as professionals.

~~~
lsc
>This is the problem. They should be obligated. Being a professional carries
ethical constraints. If your clients aren't getting your best advice you
aren't a professional, you are a salesman. It's not okay for salesmen to pose
as professionals.

Now, modern usage of 'professional' aside,(I killed a long screed about how
the only people putting effort into being seen as professionals anymore are
salespeople, thus the word is losing it's previously positive connotations.)
This idea that "professionals are trustworthy" comes from the outmoded idea
that the upper classes are somehow more honest and trustworthy than the
'working man' - that because the lawyer has more education than the plumber,
and probably comes from a higher-class background, he has a feeling of
"Noblesse oblige" - and you can therefore trust the lawyer while you can not
trust the plumber.

~~~
msabalau
Professional ethics are based on the obligations that come with specialized
knowledge and responsibility. Even professions that are solidly middle class
are seen as having duties and obligations. Librarians are expected, for
example, to resist censorship, and to protect the privacy of their patrons.

If professionalism seems less meaningful in modern society, it is because a
distressingly large number of professionals in occupations like finance are
acting dishonorably and unethically.

~~~
lsc
Fine, fine, I'll post the screed. My point is that the word "professional" is
now all but synonymous with "slick salesman"

Personally, I doubt that "professionals" were any more trustworthy before I
was old enough to notice, too... thus me poking fun at the very ideas
underpinning it.

(as an aside, I don't know all that much about finance... but as far as I can
tell, it's nothing but sales, so there really isn't any room for
professionalism in the way you mean the word. They aren't doing anything but
selling.)

My experience with people that claim to be 'professional' or who attempt to
dress professionally - nearly all of those people I know are salespeople. If
you want someone to show up on time and look good? sure, go with one of them.
If you want the correct answers to your questions? if you want someone to give
you truthful answers even when those truthful answers mean you go with a
competitor? find someone who is actually into what you are trying to do.

That's the thing, at least in the part of Engineering where I work? sure, some
good Engineers claim to be professionals, but almost none of them put any
effort into the appearances of professionalism. Few put any effort into
dressing or grooming, and many are habitually late.

The only people I know that put a lot of effort into appearing professional
are the sales people.

I mean, sure, you and I can argue back and forth all day... "Words have
meaning!" and, of course, a 'professional' is someone that does a job that
requires a lot of training, and probably comes from an upper middle class
background. But the thing is, that meaning changes over time, as how the word
is used. Personally, I associate the word 'professional' along with the
western style business suit, with fraud, mostly because the Engineers I know
don't put much effort into claiming to be professional, while most sales
people do. I think that more and more people have that opinion of the suit;
even salespeople I meet rarely wear suits, (though, of course, they still
loudly declare they are 'professionals' even though they have little knowledge
of the product and are more than happy to make up ridiculous lies about their
own product and the competition.)

~~~
billswift
"Professional always means power." Frank Herbert

Most specifically, the power to exclude competition, that is the sole real
purpose of "professional licensing", whether medical, legal, engineering, or
other. The "protecting the public" is fraudulent window dressing to impress
the suckers.

~~~
forensic
Overly cynical. If doctors did not have a professional association their
conduct would likely get worse, so there is a public interest being served
when professions self-regulate for quality. There is also an anti-competitive
factor, but corporate oligopolies do the exact same thing. Libertarians
criticize professional bodies and unions while giving monopolies, oligopolies,
and regulatory capture a free pass. This is plain stupid because it is those
corporate monopolies that are stifling human progress, not the relatively
powerless unions whether they're the white collar "association" variety or the
blue collar "union" variety.

------
Spooky23
This is why when you hear politicians bleating about de-regulation, you need
to read between the lines to figure out what they are actually saying.

Conduct of markets so critical to our society need to be done in the open, in
an publicly accessible exchange. Banks will not fix themselves, they need to
be compelled to do so by strong regulation. For all of the hand-wringing over
high-frequency trading of equities, at least you can ultimately figure out
what is doing on.

Bankers used to be boring people whose primary job qualifications were looking
distinguished and having the ability to follow instructions precisely. We need
a regulatory environment that brings that kind of banker back to the
mainstream.

~~~
jacoblyles
They are regulated. The regulators are complicit. Regulation is not a magic
bullet. Moreover, regulation is not homogenous. More regulation is not always
better/worse, and less isn't always better/worse.

Leave the talking points at home.

~~~
forensic
It's better to describe regulators as captured rather than complicit.

Regulators have no chance when the people they are supposed to regulate have
hundreds of times more power than the regulators. Allowing unlimited wealth
concentration guarantees that the most powerful private interests are always
more powerful than government regulators.

~~~
smsm42
Power would matter a lot if regulators knew exactly what to do, but lacked
power to enforce it. Unfortunately, most frequently regulators have very
little idea about where the next crisis would come from (count how many times
"unexpectedly" is featured in economical reporting) and what to do to prevent
it, and there are many contradictory opinions on these subjects. Often they
even have very little idea about what exactly major players are doing and why,
and lack the ability to foresee all the risks. Moreover, since regulators are
appointed by politicians (there's no other way to do it in democratic society)
they of course would be heavily influenced by political considerations, which
may be not to the best of the regulated industry - e.g., if politicians want
more people have access to certain loans, regulators would force banks to
accept more risk on such loans, even if it doesn't make financial sense to
them. And then if such loans blow up, the bankers would have a valid claim to
be bailed out - after all, didn't regulators ask them to accept such risks?

~~~
forensic
All of these are solvable problems.

1\. Regulators lack visibility? Give them investigatory powers.

2\. Regulators can't predict the next crisis? Maybe with bigger budgets they
would have higher quality employees. All the talent works for the hedge funds
who pay them literally hundreds of times more. If the person being regulated
makes $1M/year the regulator needs more pay than that or there will be talent
asymmetry. Obviously, the key issue here is that the financial sector gets
paid way too much, way more than the value it produces. The profits are based
on a rigged financial system.

3\. Regulators appointed by politicians due to democracy? Cancel democracy and
implement meritocracy. Require positions of power to be filled by civil
servants with proven skill who have to pass tests, rather than politicians
elected by the stupid hordes. If the masses are going to elect people that are
provably useless, the masses should be stripped of their voting privileges for
their own good. Democracy is not a panacea. Meritocracy is better.

4\. Banks upset that the gov causes them to fail? Nationalize the fucking
banks, duh. Banking is not high tech and should not be high tech. It should be
a public utility that is the most conservatively run thing in the economy.
Banks should be separated from investment entirely. Government should invest
in high tech but only using the judgment of highly qualified meritocrats with
proven knowledge elected by their specialist peers to oversee government
investment within that specialty. Private investors should have no connection
to banking.

The root of all social problems is the fact that the most qualified and
knowledgable academics and technologists have zero political power, while
Chrstian pseudo-preachers hold all of it. Intelligent people (e.g. Those on
hacker news) should be pushing technocracy and meritocracy and disempowerment
of the idiot hordes who don't even know how to act in their own self-interet.

~~~
smsm42
1\. They should know _what_ to investigate. In most cases, they don't until
it's too late. Amount of financial transactions in average bank is tremendous,
and unless you know exactly what to look for it's beyond shadow of possibility
to make sense of all of this data and see if there's any problem somewhere
there. You'd need regulatory agencies with personnel 10 times more than whole
personnel of all banks. Who'd pay for that?

2\. It's not a question of budgets. Somehow some people got the idea money is
all-powerful and enough money solves any problem. That's BS. Nobody knows
that. And yes, bankers don't know that too - do you think they enjoy being
nearly bankrupt? If they could properly predict such things, they would. They
can't, however, so instead they do what they can - dance on the line as long
as they can and cry for help when the time comes.

3\. Yeah, right. And who will be determining "merits", you? No, thanks. I'd
rathe take my chance with the stupid hordes - at least they are not so swollen
with self-importance as to deny everybody who disagrees with them basic human
rights of self-rule and control over their own destiny. All these arguments
that some people should be slaves "for their own good" and have no rights
except the right to be ruled by kind masters - we are way past that. Sorry,
those times won't return, abandon that dream.

4\. Nationalized industries work really great, duh. Of course, being
controlled by the state gives people superpowers, so industry that was badly
managed and corrupt as private, of course will become clean and well-managed
as government enterprise. After all, government enterprises are universally
known for their excellent management and total lack of corruption, especially
when it comes to managing billions of dollars. Duh.

>> The root of all social problems is the fact that the most qualified and
knowledgable academics and technologists have zero political power, while
Chrstian pseudo-preachers hold all of it.

This is completely stupid and false. The social problems have multiple roots,
and very little of them have anything to do with technologists and academics
having little power. Academics, technologists and social engineers of all kids
have huge powers and access to enormous budgets and overwhelming regulatory
powers. Most of their social engineering enterprises, however, meet with
disastrous results, exactly because every complex problem has cheap, obvious,
easy to understand wrong solution. And people like you grab at it and yell
"oh, that's simple, let's nationalize all banks and appoint more bureaucrats
to run financial industry, that would guarantee us eternal prosperity". No, it
won't, sorry.

The "idiots" are acting exactly in their self-interest when they are ignoring
advice like yours - because what you are advising is a recipe for disaster and
this was proven by history many times. Unfortunately, they don't always do
that - sometimes the simple wrong solution is too tempting. They - we - always
pay dearly for that.

~~~
Spooky23
A stable, regulated banking regime was in place in the United States until the
1980's and 1990's. The 80's saw the results of "innovation" in the financial
sector through the implosion of thousands of savings & loan institutions. We
didn't adopt our current _laissez faire_ regime of "bankers gone wild" until
the late 90's.

My memory may be foggy, but I don't recall the period of 1945-1999 as some
sort of socialist nightmare for the United States. Most people think of this
era as a golden age.

Regulation doesn't mean nationalization. It means that you put rules in place
to do things like eliminate practices the fundamentally place the bank at odds
with their customers. Things like using the customer deposits to make multi-
billion dollar gambles (JP Morgan Chase, MF Global). Or subject the firm to
tend of billions of dollars worth of liability that the firm is unable to make
good on (AIG). Or commit outright fraud (Countrywide, Washington Mutual,
Barclays, etc).

I don't work in the financial industry, so the normal laws of business apply.
If I systematically broke internal controls and rigged KPIs to achieve the
maximum bonus compensation possible for me, I'd be investigated, terminated
and likely prosecuted. Why shouldn't the guy managing my money have the same
accountability?

~~~
smsm42
If you call current situation in financial industry laissez faire you
obviously have no idea what these words mean. Yes, there was some deregulation
in 2000s, but there was still huge amount of regulation and government control
over the financial industry. None of these controllers foresaw the crisis of
2008, none of them objected to subprime mortgage industry - actually, most of
the politicians sung praise to raising home values, better access to
homewonership for the poor, and upcoming prosperity for all, and pressed the
banks into doing more to help the poor take the loans to get on the property
train.

Check out this book, promising ever-rising home prises in 2005:
<http://www.amazon.com/gp/product/0385514344>

Now check out the glowing reviews of this book, quoted on the same page, by no
other than chiefs of Federal Reserve and Fannie Mae. You are telling me the
problems happened because guys like these didn't have enough power? I've got a
nice bridge for sale in Brooklin, are you interested?

>> Regulation doesn't mean nationalization.

For the guy on whose post I was responding it definitely does. Not only
nationalization, but also removing democracy and rights of self-rule for
everybody but people having enough of some "merit", which I suspect he assumes
himself to possess in abundance. I am glad the problem with such suggestions
is obvious for you.

------
tom_b
Benford's law strikes! I was all set to read about crazy, complex data
analysis that detected this, but instead check out the abstract below:

"With an eye to providing a methodology for tracking the dynamic integrity of
prices for important market indicators, in this article we use Benford second
digit (SD) reference distribution to track the daily London Interbank Offered
Rate (Libor) over the period 2005 to 2008. This reference, known as Benford's
law, is present in many naturally occurring numerical data sets as well as in
several financial data sets. We find that in two recent periods, Libor rates
depart significantly from the expected Benford reference distribution. This
raises potential concerns relative to the unbiased nature of the signals
coming from the 16 banks from which the Libor is computed and the usefulness
of the Libor as a major economic indicator. "

Abrantes-Metz, R. M., Villas-Boas, S. B., & Judge, G. (2011). Tracking the
Libor rate. Applied Economics Letters, 18(10), 893-899.
doi:10.1080/13504851.2010.515197

------
ntharani
I say this as an outsider to the industry, but the 'large' £290m penalty
appears to be a joke and the media are either complicit or too thick to
realise. Annual profits for Barclays were £5.9 billion to Q1 this year. May
not be appropriate for comparison purposes, but if over a year the financial
penalty Barclay's paid was the same basis as the penalty for dodging a £2 tube
fare in central london - the fine for being caught would be just south of a
whopping 10 pence! Simple incentive theory here. At that rate I'd dodge the
fare every. single. day. The fine (reputation damage be damned as I'm not sure
there is a honest broker to take my business to) is off by at least 2 orders
of magnitude.

~~~
JumpCrisscross
The philosophy is it isn't fair to penalise non-complicit employees,
shareholders, and other stakeholders. Thus, when possible, the directors are
decapitated and those responsible are charged personally.

Note that it wouldn't be productive for regulators to fine banks into needing
to be rescued. I also suspect they're being cautious in light of the torrent
of asymmetric lawsuits and contract unwindings about to hit these banks.

~~~
steve19
That line of reasoning is why we have so many problems.

The banks profited immensely from the manipulation, at the expense of other
companies around the world (and their shareholders, employees, stakeholders).

If the directors knew about it, then they should be punished, as should the
employees directly involved, but so should the bank itself.

If shareholders thought that companies they owned were immune from punishment,
it would create an incentive for them to try pressure directors or employees
of the company into doing morally or legally dubious things.

Sadly, this type of corruption looks to me to be far to deep for simple fines
to fix. There is a rotten culture in London that needs to be removed.

It reminds me of the Enron recordings [0] ...

> "This is going to be a word-of-mouth kind of thing, We want you guys to get
> a little creative and come up with a reason to go down."

> "O.K., so we're just coming down for some maintenance, like a forced outage
> type of thing? And that's cool?"

> "Hopefully," Mr. Williams says, before both men laugh.

[0] <http://www.nytimes.com/2005/02/04/national/04energy.html>

------
haberman
What blows me away about this story is that, as far as I can tell, the entire
financial world is built on this rate that is calculated by taking completely
unverified estimates from a handful of enormous banks who have every incentive
to manipulate those estimates. How on earth is such a conflict of interest
allowed to parade around out in the open? And why should we have any reason to
believe that there aren't other similarly absurd structural problems with the
financial system? The whole thing sounds like a house of cards.

~~~
lifeguard
The LIBOR is widely used, but there are others like the Fed's prime rate, and
the consumer price index.

The entire entire financial world is built on insider manipulation. Too many
examples to list.

~~~
haberman
I just don't understand why things are pegged to indexes at all instead of
just letting prices be naturally determined by supply and demand. If prices
are determined adversarially, then there is no room for manipulation or
conflict of interest. Why have these indexes at all?

Put another way, who is willing to buy or sell according to prices that are
open to manipulation (by being pegged to something like LIBOR), and why are
they willing to do this? And why shouldn't competition favor produce better
alternatives like financial instruments that aren't pegged to any artificial
index?

~~~
crasshopper
_why shouldn't competition produce ... financial instruments that aren't
pegged to any artificial index?_

There are those, too, but people want to hedge against the risk that "interest
rates" move.

Then they must define "interest rate": is it mortgages in Peoria? Car loans in
Manila? 30-year Treasurys? ... Well, how about we use LIBOR.

------
lifeisstillgood
Imagine a slightly sweaty central banker dancing on stage:

    
    
      Transparency, transparency transparency, transparency ...
    

So much of the problems since 2008 arise because it was not known what others
were borrowing or lending or from whom at what price.

The LIBOr rate is set by asking not what rates do you borrow at, but what rate
would you like to borrow at!

Sorry folks, commercial confidentiality is a fig leaf too far now. Publish and
be damned.

~~~
JumpCrisscross
»" _LIBOR is set [at]...what rate would you like to borrow at_ "

No, it's not. It's supposed to be what rate the bank _estimates_ it _could_
borrow at. You can't use actual transactions because there are very few actual
uncollateralised interbank loans at each of the LIBOR tenors.

»" _commercial confidentiality is a fig leaf too far now_ "

One of the issues with LIBOR is it discloses what rate each of the banks
report. Thus banks and regulators have an incentive to under-report rates to
prevent launching a feedback cycle.

~~~
lifeisstillgood
But if we knew what they were _actually_ borrowing at

1\. LIBOR would be accurate and not open to manipulation

2.

3\. if a bank is weak it should find it harder to borrow. Feedback cycles can
be beneficial, plus this sounds a lot like the old "the ratings agencies told
me this sub prime mortgage was actually AAA". - if you are investing billions,
do your own damn research. And your own damn research is a lot easier in a
transparent market.

In the end I think the global finance industry is a threat as well as a
benefit. We are happy to demand access to politicians finances, because it is
their character that matters so much, a situation very similar to banks it
seems.

------
cs702
"Banks, as presently constituted and managed, cannot be trusted to perform any
publicly important function, against the perceived interests of their staff.
Today’s banks represent the incarnation of profit-seeking behaviour taken to
its logical limits, in which the only question asked by senior staff is not
what is their duty or their responsibility, but what can they get away
with."[1]

[1] [http://blogs.ft.com/martin-wolf-
exchange/2012/07/02/banking-...](http://blogs.ft.com/martin-wolf-
exchange/2012/07/02/banking-reforms-after-the-libor-scandal)

------
Avitas
This long-term fraud is one of the better cases for which there are likely to
be thousands of individuals who should be held criminally and financially
responsible. It is clear that many financial institutions will be held
responsible.

If the thousands or even perhaps tens of thousands of individuals involved are
forced to pay restitution damages in addition to punitive damages, would this
further the cause of justice? I am of the mindset that it will. Do the world's
prosecutors and politicians have the balls and/or resources to do it?

~~~
politician
It may be all well and good to crucify ten thousand people, but unless there
is a plan in place for the aftermath we'll still have a broken system ... and
a lot of bodies, _figuratively speaking._

~~~
gruseom
_unless there is a plan in place for the aftermath_

Ooh! I know a good plan! How about we investigate and prosecute fraud? The
idea is that this would create an incentive not to commit fraud in the future.

Former bank regulator William K. Black says that the agency he worked for
during the 1980s S&L crisis made over 10000 criminal referrals to the Justice
Department, producing over 1000 felony convictions. That crisis was 1/70th the
size of this one. How many criminal referrals have been made in this one?
Zero. How is that possible? The answer Black gives is: total gutting of the
investigatory system. What you don't look for, you don't find.

That's a long runway for due process before anyone needs to dust off words
like "crucify".

(I'm not giving a citation because although the above is easy to google, I
don't know which of the websites are any good. I got it from watching
interviews. Is Black credible? His experience in the field seems exemplary.)

~~~
anigbrowl
If you change the law such that many behaviors which were once illegal are now
legal (which some would argue was the upshot of repealing Glass-Steagall),
then the negative consequences which may ensue aren't necessarily criminal.

~~~
gruseom
According to Black and others, plenty of behaviors remain illegal that are
simply not being investigated.

------
Confusion
Robert Reich[1] in <http://robertreich.org/post/26708840314>:

    
    
      And it would amount to a rip-off of almost cosmic
      proportion – trillions of dollars that you and I and other
      average people would otherwise have received or saved on
      our lending and borrowing that have been going instead to
      the bankers. It would make the other abuses of trust we’ve
      witnessed look like child’s play by comparison.
      
      Sad to say, there’s reason to believe this has been going 
      on, or something very much like it. This is what the 
      emerging scandal over “Libor” (short for “London interbank 
      offered rate”) is all about.
    

[1] Chancellor’s Professor of Public Policy at the University of California at
Berkeley, was Secretary of Labor in the Clinton administration.

------
lifeguard
Manipulation of the LIBOR would impact all the variable rate mortgages that
are indexed to it. In California, home loans with a 0% interest rate for the
first year and very low rate for next few years (negatively amortized) were
very popular and pushed by Washington Mutual and other banks. But these loan's
interest rates were tied to the LIBOR. A lot of foreclosures were do to these
types of loans where the payment will increase 10 - 20%. How often does ones
income increase 20% in a year or two?

The economist article is not exaggerating IMO.

How these banks are dealt with by our governments will illuminate the extent
banks have corrupted our governments.

------
brunorsini
Public companies should just be forbidden to do speculative prop trading at
all. If one does and is lucky for a couple of years, then all others need to
follow suit to achieve compatible profit levels... And that gets everyone
stuck in a stupid rat maze that benefits society just as much as ebola or
scientology.

------
awayand
Just like any group, organization, family, company, establishment: A fish rots
from the head down. The system has to be setup in such a way, that the heads
of an organization are least likely to start "rotting": \- checks and balances
\- personal liability \- transparency

------
tomrod
I wonder if the outrage at this particular practice will fuel politicians?

~~~
jwb119
I'm sure it will. Will they fix anything, and if they do will the fixes be
another produce better results, is another question.

~~~
politician
"We have to pass the bill to find out what's in it."

