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Good Banks Turn Bad: Barclays, Libor and Me

With 16 banks, including Barclays, being investigated for Libor manipulation and fraud, outrage is entirely appropriate. But when I first read this story, I had a somewhat different reaction due to my own personal Barclays story.
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It's looking like arrests are imminent in the Libor scandal, with U.S. and European investigators closing in on more than a dozen traders. It is impossible not to be outraged by flagrant deception: For at least four years -- from 2005 to 2009 -- Barclays Bank, among, apparently, many others, intentionally manipulated the interest rate benchmark Libor (the London Interbank Offered Rate), to which trillions of dollars of financial instruments, including millions of mortgages, credit card rates, and small business loans, are pegged. In the last week of June, Barclays reached an agreement with British and American regulators to pay a $450 million fine, and three top officials of the bank, including CEO Robert Diamond, resigned.

Just how serious is the scale of this fraud? Some say that the amount tied to Libor is $360 trillion, some say $500 trillion, while others put it as high as $800 trillion.

"Manipulating the Libor is a big deal because it affects the cost of money for almost everyone," writes Gretchen Morgenson. Or, as Dylan Matthews puts it, "a bank that mucks with the LIBOR rate isn't just playing around with esoteric derivatives that will only affect other traders: They're playing with the real economy that most of us participate in every day." Robert Reich puts it in even starker terms, calling it a "mammoth violation of public trust," a "rip-off of almost cosmic proportion," and "insider trading on a gigantic scale." Matt Taibbi, who's been on this beat long enough to be hard to shock, writes that "this story is so outrageous that it shocks even the most cynical Wall Street observers." An experienced Wall Streeter tells Taibbi that "it's like finding out that the whole world is on quicksand." Says one official involved in the investigation, "It's hard to imagine a bigger case than Libor."

So, yes, outrage is entirely appropriate. But when I first read this story, I had a somewhat different reaction due to my personal connection to the bank. No, this isn't where I come clean about helping to fix the Libor in my spare time. My story took place in London, when I was 25 years old and had just written my second book. I thought it was ready to be published, but publishers felt differently -- 25 of them rejected it. It was one of the lowest points in my life. So one day, having run out of money, I found myself walking on St James's Street mulling things over -- as in, "maybe I need a different career." I saw a Barclays Bank and had an idea -- the impulsive kind that you wouldn't act on if you thought about it too much. I went in and asked to see the manager. We sat down and, armed with no collateral but a bit of chutzpah (or naiveté -- there's a fine line), I explained the situation and asked him for a loan. He thought it over and gave me a loan. His trust in me actually changed my life, since it allowed me to keep going for another 13 publisher rejections... and one "yes." His name was Ian Bell and he, and Barclays Bank, have always had a special place in my heart (I still send him a Christmas card every year).

So in my memory, Barclays has always been the good bank, the caring, customer-centered bank, even as recent years have shown more and more banks to be far from good. It's a story that I tell in my speeches and talks -- a well-thumbed part of my personal narrative. But now the good bank of my memory has become, like so many others, a bad bank. It's always something of a shock when institutions or people who have played pivotal roles in our lives turn out to be something other than what we thought they were. But it's now clear that the Barclays of my early years in London is quite different from the Barclays of today. It wasn't so much that Barclays had changed, but that banking itself had changed. Barclays just joined the club.

In fact, 16 banks are being examined for manipulating the Libor or other rate indexes, and investigations are under way in practically every industrialized country. The civil litigation will stretch on for years, perhaps decades. Morgan Stanley estimates that total costs for the banks involved could reach $14 billion, while another report puts the number closer to $35 billion. "This is the banking industry's tobacco moment," said one bank's chief executive. "It's that big."

The Libor is calculated daily by asking major banks the rate at which they estimate they could borrow money from other banks. The result is compiled by Thomson Reuters and released by the British Bankers Association (the New York Times has a good interactive explainer here).

It appears the manipulations were actually for two different purposes. One was simply to game the system so the banks' casino bets would win out, and the other was, during the height of the financial crisis, to hide the true health of the banks from regulators. The latter reduced the likelihood that the political system would put in place real reforms. "It seems reasonable to assume," writes HuffPost's Peter S. Goodman, "that artificially low Libor readings emboldened ongoing risk-taking that made the resulting disaster worse -- a disaster whose costs are still being borne by ordinary people who lost jobs, homes and savings in multiple countries."

Not that real reform would have been put in place if regulators had known the truth. How do we know this? Because, in fact, it turns out they did know. Recently released documents show that regulators in both the UK and the U.S., including the New York Fed and its then-leader Tim Geithner, knew that Libor was being rigged as far back as the fall of 2007. "We did the right and the necessary thing, and we did it early," Geithner recently told CNBC's Larry Kudlow. "We were very forceful from the beginning." And what does "very forceful" mean? It means they wrote a memo with some gentle suggestions. "We brought it to the attention of the British and took the exceptional step of putting into writing to them a detailed set of recommendations that revealed the extent of the concerns in that context," says Geithner.

It's bad enough the response was just a tepid memo instead of a clear warning to the millions of Americans who were being ripped off and whom, ostensibly, it's the U.S. bank regulators' job to protect. But even most of the suggestions in the memo were, as it turns out, straight from the banks themselves. "The recommendations Geithner sent to London did not come from staff," writes HuffPost's Ryan Grim, "but rather were proposed by major banks and more or less forwarded on verbatim." The Fed defends itself by saying that the recommendations were "the result of its own analysis." In fact, both are probably true -- given the lack of separation between the Fed and the bankers it oversees, the two are, to a great extent, one and the same. They're like different departments of the same company. So why not just take the banks' recommendations? They would have been the same as the Fed's anyway, so why even rewrite them?

"It looks like they had pretty explicit notification of some very bad behavior, and I don't understand why they didn't investigate," says Sheila Bair, former chair of the FDIC. "They did have authority to do that." But not, apparently, the will.

For its part, the Bank of England had the idea to set up "a panel of senior bankers overseeing" the Libor process. Yeah, that should work. Let the banks regulate themselves. Oh wait, that's the system we already have.

Not surprisingly, by late 2008, months after Geithner's "forceful" response, a Barclays exec told an official at the New York Fed that the index was still "absolute rubbish." Or, as UK Business Secretary Vince Cable said of the entire British banking sector, the whole thing is a "massive cesspit." Just how brazenly lawless the banking world has become can be seen in the casual tone of the emails unearthed in the investigation. "Dude. I owe you big time! ... I'm opening a bottle of Bollinger," read one. Another trader would write himself notes in his planner to remind himself to fix the market that day: "Ask for High 6M Fix." Yet another would, as The Economist put it, give a "shout out to colleagues that he was trying to manipulate the rate to a particular level, to check whether they had any conflicting requests." How thoughtful. It's nice to see that kind of etiquette in the banking world, making sure none of your colleagues are rigging the system in a different way than you're planning to rig it.

This isn't how master criminals talk -- there's no hush-hush, burn-this-letter-after-reading drama. It's the banal, everyday tone used by people who assume this is just how things are done. And, by and large, this is how things are done. It's hard to blame the front-line traders who were actually doing the rigging. What they were doing was of a piece with how banks have operated for most of those traders' careers. The problem isn't a few bad apples, though that's how the industry is going to try to portray it. "Banks are hoping that at least regulators will see that the scandal was mainly due to individual misbehavior of a gang of traders," said a European source. As London lawyer Richard East put it, "They'll obviously score direct hits with the particular traders, but will they catch the big fish? I don't think so."

And that's because the big fish are in a revolving door (or aquarium) with those overseeing the system. "It also shows how hard it is to get to the bottom of a controversy," editorialized the New York Times, "when the officials in positions of power now... are the same people who were running things when the misconduct occurred."

Much is made about the need to change the banking culture -- which is certainly true. But until the entire system is fixed to change the incentives, there's no amount of tsk-tsking and bad-apple-squeezing that will keep things like this from happening again. "[There is] clear evidence in the U.S. and UK that these banks are nearly impossible to manage, orientated to the wrong corporate objectives and still overseen by managers who bust the world and their industry five years ago," said Neil Dwane, CIO of Allianz Global Investors Europe.

It's not that bankers have somehow suddenly become bad guys; it's that concrete decisions were made to change laws in a way that made scandals like this, and the banking culture that goes along with it, inevitable. It was the deregulation of the '80s and '90s that allowed banks to morph from local institutions that knew their customers -- that would make small business loans based on trust and face-to-face contact -- into the dangerous, near-lawless casinos they are today.

When talking about the pre-casino incarnation of banks, people often use the word "boring" to describe them. For example, here's Elizabeth Warren:

I'm somebody who believes we really should have boring banking. That banking should be the part that's about savings accounts, some checking accounts and our money system should be separated from the kind of risk taking that Wall Street traders want to take. That was originally what the Glass-Steagall Act was about. It was repealed in 1999. ... I think we really do need that kind of separation. We need to go back to boring banking. The people who want to take risks need to take risks with their own money and do it somewhere else, not in the banking system.

Likewise, here's Joe Nocera: "What banking most needs is to become boring, the way the business was before bankers became addicted to trading profits."

I completely agree with their prescription that banking go back to what it was. What I disagree with is that this is necessarily boring. One of those boring, small-time decisions changed my life. The financial stakes of pre-casino banking may be much lower in dollar terms, but the human stakes are huge. The ability to engage with somebody face to face, to hear them out, to trust them and take a risk based on that trust that could change a person's life -- that doesn't seem boring to me. Those who consider it boring and are only excited by making huge casino bets can continue to do so, just not with house money backed up by taxpayers. "I just want all this garbage out of insured banks," said Sheila Bair. "A bank with insured deposits should be making loans. If they have excess they should put the money in safe government securities."

"There is rot at the core of the financial system," wrote Elizabeth Warren last week.

The nature of the rot can be seen in one amazing exchange between a Barclays trader and an official from the New York Fed in April 2008.

"We know that we're not posting um, an honest LIBOR," says the trader, "and yet we are doing it, because, um, if we didn't do it, it draws, um, unwanted attention on ourselves."

"You have to accept it," replies the Fed analyst. "I understand. Despite it's against what you would like to do. I understand completely."

In fact, we all do. We all understand how rotten the system is, but we don't have to accept it. So, yes, let's investigate and prosecute all those responsible for the Libor scandal, in every country and in every bank that was involved. But LIBORgate isn't the problem -- it's a symptom. And until we separate the banks from the casino, more symptoms will appear. Hopefully one day, when we no longer accept what we know to be a rotten system, I can go back to my fond memories of Barclays Bank. That would be real cause to open a bottle of Bollinger.

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