Monday, July 23, 2012

Elizabeth Warren: Libor fraud shows Wall Street's rotten core

In her Washington Post column, Elizabeth Warren looks at the financial system and asks does Wall Street have so many friends in Washington and London that it cannot be fixed.

Everyone knows that all of the problems that have emerged in the financial system over the last few years have come from the opaque, corners of the financial system (structured finance securities, banks and now, Libor).

Opaque areas that exists because as Yves Smith at NakedCapitalism says, 'no one on Wall Street was ever compensated for creating low margin, transparent products'.  Opacity is the key to Wall Street current level of profitability and hence bonuses.

Opacity lets Wall Street engage in bad behavior in pursuit of their bonuses (think Libor manipulation and treating clients who think there is a fiduciary relationships as counter-parties for zero-sum trades).

Regular readers know that your humble blogger refers to Wall Street's friends in Washington and London as Wall Street's Opacity Protection Team. It is not just the banks, but the regulators and policymakers who are complicit in allowing Wall Street to create and maintain large opaque areas in the financial system.

Everyone knows that transparency and hence sunshine is the best disinfectant.  However, sunshine would make it harder for Wall Street to make money as everyone would have access to all the useful, relevant information in an appropriate, timely manner for making a fully informed investment decision.

Ms. Warren's question is really does Wall Street have so many friends in Washington and London that will help it protect the profits it makes from opacity that transparency, trust and integrity cannot be restored in the financial system?

The Libor scandal is more than just the latest financial deception to come to light. It exposes a fraud that runs to the heart of our financial system. 
The London interbank offered rate is a benchmark for a range of interest rates, and the misdeeds making headlines have to do with how those rates are set. If insiders can manipulate the basic measurement of a loan — the interest rate — there is rot at the core of the financial system. 
The British financial giant Barclays has admitted to manipulating the rate from 2005 to at least 2009. When the bank made a bet on the direction in which interest rates would turn, the Barclays employees who submit data for calculating interest rates would fake their numbers to help Barclays traders win the bet. Day after day, year after year, bet after bet, Barclays made money by fixing bets for its own traders.... 
It is also clear that many of those who didn’t have a fixer — including consumers, community banks and credit unions — lost money. 
Barclays padded its bottom line by taking money from everyone else. It won when it shouldn’t have won — and others lost when they shouldn’t have lost. 
The amount of money involved is staggering. On any given day, $800 trillion worth of credit-related transactions are linked to Libor rates. 
In most markets, consumers could simply take their business elsewhere once they learned that the scales were rigged. But interest rates are different. Everyone who borrows money on a mortgage, credit card, student loan, car loan or small-business loan — basically, everyone — is affected by a crooked market on Libor....  
Even those who didn’t borrow but saved for retirement or their children’s future got hit with interest rates that had been faked. 
It gets worse. During the financial crisis, Barclays and other banks also appear to have consistently manipulated Libor to show lower-than-real borrowing rates to convince the world — and their regulators — that the bank was stronger than it really was. In other words, they rigged the interest-rate reports so that no one would know exactly how much trouble they were in. 
With a rotten financial system once again laid bare to the world, the only question remaining is whether Wall Street has so many friends in Washington that meaningful reform is impossible....
Going forward, the rules would be changed so that Libor is calculated on actual borrowing costs, not estimated or claimed costs....
An idea your humble blogger presented to readers as part of requiring banks to provide ultra transparency.  Under ultra transparency, banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This allows Libor to be calculated off of actual trades.

This allows market participants to assess the riskiness of each bank on an ongoing basis and adjust the amount and price of their exposures to each bank based on this assessment.  It is this ability to make ongoing risk assessments that unfreezes the interbank lending market and keeps it from freezing in the future.
But the heart of accountability lies deeper. It rests on acknowledging that we cannot trust Wall Street to regulate itself — not in New York, London or anywhere else. The club is corrupt.
When Mitt Romney says he will move to repeal all of the new financial regulations, he supports a corrupt system. When members of Congress grill regulators for being too tough on Wall Street and slash the budgets of the regulators charged with overseeing Wall Street, they prop up a corrupt system. 
Financial services are critical to the economy. That’s why everyone — every family and every business — has a stake in an honest system. The fantasy that reducing oversight of the biggest banks will make us safer is just that — a dangerous fantasy. The Libor fraud exposes rot at the core. Now, who will stand up to fix it?
Who will stand up for bringing transparency to all the opaque corners of the financial system.

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