Wednesday, July 4, 2012

BBC's Robert Peston: 'elusive truth of Barclays' lie'

In an important article, the BBC's Robert Peston exposes the simple fact that trust and transparency go together.  At the same time, he confirms the wisdom of Walter Scott's observation: Oh! what a tangled web we weave when first we practice to deceive.

Aside from the forensic analysis about who said what to whom, there is a very simple question at the heart of the furore of Barclays' involvement in the LIBOR-rigging scandal: is it ever acceptable to lie? 
At the height of the banking crisis in 2007 to 2008, I as an enquiring journalist was routinely lied to by bankers: they claimed they were able to borrow from conventional sources relatively easily and were not on the brink of financial collapse. 
In the case of HBOS and Royal Bank of Scotland, we subsequently learned this was untrue...
Why was there this climate of deception?

The reason for this climate of deception has to do with how the financial regulators reacted to the fact that they had clearly failed in their primary mission to protect the taxpayer from losses should a bank run into financial trouble.

Recall that regulators do not approve or disapprove of any position taken by the banks (if regulators did approve of positions, they would be the ones who were responsible for allocating capital to the real economy).  Rather, regulators try to estimate how much the bank could lose on the position.  Banks are required to hold at least enough capital to cover the regulators' estimate of loss.

The financial crisis exposed the simple fact that the regulators' estimate of losses was considerably less than the actual losses that occurred.

Regulators responded by trying to cover up this fact.  Example of this include suspending mark-to-market accounting and adoption of regulatory forbearance under which banks kept zombie borrowers alive by practicing 'extend and pretend'.

There was an appalling climate of fear, in which no bank felt completely confident of survival. 
Now in this climate, Barclays was among the least trusted of the banks. Investors, for years, feared they didn't properly understand how its complex investment bank earned its profits. Ministers and officials felt it was arrogant and opaque as an institution. 
Despite access through the examiners sitting at Barclays to all of Barclays current asset, liability and off-balance sheet exposure details, ministers and officials thought it was opaque.

Imagine how investors and other banks felt who did not have access to these details.
I know this because it was one of the big talking points in my milieu. 
It was this lack of trust which meant that Barclays had to pay more to borrow than other banks: for any creditor, trust in the borrower is probably more important than anything else; and any uneasiness about the strength of the debtor translates into the debtor paying a higher interest rate. 
Now I recall talking about the relatively high rate Barclays was paying to borrow to people in government and Whitehall. It was both intriguing and disturbing to them. 
As it happens, Bob Diamond's note of his conversation on October 29 2008 with Paul Tucker, deputy governor of the Bank of England, implies he was having similar conversations with the ministers and officials of SW1. 
Many would say that the proper lesson for Barclays from these funding tensions was that it needed to regain the trust of the market - by perhaps simplifying its operations and making them more transparent. 
Please re-read the highlighted text as Mr. Peston makes the case for requiring not only Barclays, but all banks to provide ultra transparency.
What we learned from the regulators' verdict on Barclays last week was that in fact its response was to lie about its borrowing costs: it understated them to try to reassure the market. 
Barclays' defence is that it was dreadfully unfair that its perceived borrowing costs were higher than other banks. And it is convinced that many of these banks were even bigger liars than it was about what they were paying to borrow. 
It also points out that in practice its balance sheet, its finances, were in fact stronger than many of these other banks: its creditors were wrong, it would say, to have so little trust in it. 
Oh, what a tangled web we weave....

Had Barclays provide ultra transparency in the first place, market participants could have trusted its performance and rewarded it with a much lower cost of funding.

Think about how much money Barclays and other banks had to make off of opacity to offset the value of having lower cost funding!

If Barclays had to pay a premium of 5 basis points (5/100s of 1%), based on the size of its balance sheet we are talking hundreds of millions per year in excess cost as a result of opacity.
So was its lie about what it was paying to borrow justified - especially if the survival of the bank was at stake? And if Paul Tucker at the Bank of England encouraged Barclays to lie, as is implied by Diamond's memo, would he have been justified in doing so? 
As it happens, a number of senior figures in the City who are unconnected to Barclays think this lying was the right thing to do in the circumstances. They think Mr Tucker encouraged Barclays to lie and they applaud him for doing so. 
You might well say that is evidence of a cancerous moral relativism at the heart of the City. Or you might applaud their common sense realism. 
Or you could be like your humble blogger who thinks that the key lesson of the financial crisis is that regulators need to ensure that the bright light of transparency shines in all of the opaque corners of the financial system.

It is only with ultra transparency that sunlight can act as the best disinfectant and bring about changes in the culture of banks.
We need Paul Tucker's side of the story to evaluate whether he did indeed nudge Mr Diamond to a policy of economy with the truth on the bank's borrowing costs - and, if he did so, whether he was responding to pressure from what Mr Diamond calls "senior figures in Whitehall". 
But here's a question for you: was Barclays making a small lie for a bigger purpose; or was its instinct to lie at the very heart of the problem, the reason why it was so little trusted in markets and was having to pay more than others to borrow?
It has been well known since the Great Depression that bankers will use opacity to engage in bad behavior.  By its actions, Barclays confirms this.  As the Libor investigation continues, many other banks will also confirm this.

The role of the financial regulators is to prevent opacity from establishing itself in the financial system.  Clearly, the regulators failed in two areas:  bank balance sheets and structure finance securities.

The result of bankers using this opacity to engage in bad behavior is clear.

It is also clear that the first step towards repairing the financial system is to introduce transparency into all the opaque corners.  Your humble blogger thinks banks and structured finance securities should be the first to experience the benefits of sunlight!

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