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Time to Rebuild

All Things Considered - September 2012


August 21, 2012
By Jim Knisley


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The old line says that it is better to beg forgiveness than ask permission. But when you’re dealing with trillions of dollars in capital, hundreds of billions in potential profits and tens of millions in personal bonuses, that seems particularly true. International bankers certainly understood it. Knowing they were too big to fail and that governments had their backs no matter what happened, they played fast and loose with other people’s money.

There were the mortgage schemes, the bundling of financial assets that individually have the attractiveness of week-old garbage but were peddled as golden, as well as bets on derivatives, interest rates, stocks, bonds and commodities. One writer for The Guardian compared it to an unlicensed casino where every game is rigged and there are no effective rules or laws. And the worst that could happen if they were caught would be millions in fines that would take just a tiny bite from the billions in profits.

All of this is well known. The great international recession that began in 2008 and still continues to this day was financial in its origins. In the U.S., Ireland, Iceland, Britain, Spain and elsewhere, it began with the banks and other financial institutions. When loans that never should have been made went bad and bets went against them, they turned to governments that touted deregulation and the sanctity of free enterprise for billions in bailouts.

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What the public didn’t know until this summer was that the schemes didn’t end with playing fast and loose and not acknowledging or recognizing the risks of the bets.

The latest and likely not the last scheme to be revealed reached all the way down to a financial fundamental. Major international banks played with what is known as the LIBOR rate for their own benefit.

The LIBOR rate is the rate at which international banks make unsecured loans to one another. It is, in effect, the base rate. Other loans – mortgages, car loans and lines of credit – are based to one degree or another on LIBOR. It is estimated that LIBOR affects $500 trillion, give or take a few trillion, in transactions.

By gaming that system they could affect everything. If derivatives, unsound mortgages and other strange financial instruments were a financial system on steroids, it goes even further. It is as if a high jumper had the ability to adjust gravity for his benefit and to the detriment of competitors.

What makes the whole thing particularly smelly is that it occurred in London and is in part the result of persistent lobbying by the banks to be freed from the shackles of regulation. They succeeded: self-regulation was designed to free the banks from red tape in the name of profits and free enterprise was the rule. And the world has seen the consequences.

Governments put the fox in charge of the henhouse and seem surprised at the result.

The Economist magazine – hardly a bastion of the left – weighed in with an editorial early this summer simply headlined “Banksters.”

“Yet despite the risks of banker-bashing, a clean-up is in order, for the banking industry’s credibility is shot,” they wrote.
The New York Times quoted George E. Barnett, professor of law and finance at the University of San Diego School of Law: “I wish I could say I’m shocked, because it is shocking. But regulators have not been particularly effective or aggressive in the past two decades of finance.”

And it is not as if regulators didn’t know the game was rigged.

In 2008, officials at the New York Federal Reserve wrote in an internal memo that banks appeared to be understating the interest rates they would pay. “Our contacts at LIBOR contributing banks have indicated a tendency to underreport actual borrowing costs,” they wrote. But, they were a little late to the game.

Traders with London-based Barclays Bank were trying to manipulate LIBOR and another benchmark rates to enhance their trading profits at least as early as 2005.

But even after regulators became aware of the schemes, they worried that dragging a major bank (or banks) into court would shake confidence in the international financial system and result in chaos. But by not acting they got much more.

The biggest banks were saved, but the U.S. mortgage crisis still drags on and a growing number of municipalities are declaring bankruptcy. In much of Europe, unemployment is chronic and nations are at the brink. Canada, thankfully, is in better shape but not immune.

Millionaire bankers – or banksters – are not popular. Confidence in international finance has been shattered. But the buck, while it may go into their pockets, doesn’t stop with the bankers.

Deborah Orr, writing in the Guardian, put responsibility at the feet of politicians.

“The crisis, however, has not been in finance…. Global Governmental Crisis would be a more apposite title for this ongoing chaos. And the political chaos is simply a consequence of political failure to fully acknowledge what went wrong with banking, and determinedly set about fixing it.”

She is right. Politicians must stop fearing the possible consequences of tough banking regulation and look at what weak regulation has wrought. The system is broken; it’s time to rebuild it.


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