Friday, July 27, 2012

Tim Geithner's handling of the Libor scandal exemplifies why financial markets should not be dependent on regulators

A Wall Street Journal column looked at Treasury Secretary Tim Geithner's handling of the Libor scandal and concludes that it is a mistake to make the global financial system more dependent on regulators.

It is always nice to have the Wall Street Journal agreed with your humble blogger.
Timothy Geithner sure does lead a charmed life. As a powerful regulator [before], throughout the financial crisis and its aftermath, he gets to blame every mistake or scandal on the evil bankers while claiming he was hot on their case all along. 
This pose is wearing especially thin on the much-ballyhooed Libor rate manipulation scandal. 
Facing Congress this week, the Treasury Secretary stuck to his story that as president of the New York Federal Reserve in 2008 he was blowing the whistle on Libor manipulations even as he let everyone in the world continue to use Libor as a benchmark—including his own Fed. 
Mr. Geithner told a House committee that he "personally raised [the matter] with the Governor of the Bank of England" and later sent him "a very detailed memorandum" on how to fix the "incentive" and "opportunity" for banks to "underreport" their borrowing costs under Libor. 
Regular readers will recall that the email from Mr. Geithner to the Governor of the Bank of England failed to mentioned that a Barclays trader had told the NY Fed that its Libor submissions were fraudulent.

Regular readers will also recall that the very detailed memorandum on how to fix the "incentive" and "opportunity" for banks to "underreport" their borrowing costs under Libor was a series of six talking points from the banks that were manipulating Libor.

Naturally, none of the six talking points would have done anything to stop the ongoing manipulation of Libor.  Not one talking point suggested that Libor be based off of actual transactions.  Not one talking point suggested that banks provide far greater transparency so that market participants could see how the transactions included in Libor compared with all the transactions the banks did.
At the same time, however, he admitted that the Fed used Libor as the benchmark for several bailout programs because it was "the best rate available at the time." If a rate that the head of the New York Fed knew was subject to manipulation was "the best rate,"....
There really is not much more that needs to be said when one of the most important financial regulators makes the argument that a manipulated rate was 'the best available at the time'.

Not only that, but we know the other financial regulators agreed with him because he had told them Libor was manipulated and they still used it as the benchmark for several bailout programs.

The only conclusion that can be drawn from this statement and the related actions is that where ever possible, the stability of the financial system must be independent of whether or not the financial regulators perform their job.

Based on this conclusion, it is imperative that the financial regulators be stripped of their monopoly on all the useful, relevant information on each bank.  Stripping the regulators of their information monopoly requires that the banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this disclosure, Libor can be based off of actual trades.

With this disclosure, market participants can end their dependence on the financial regulators and independently assess the risk of each bank.  With this assessment, they can adjust the amount and price of their exposures to reflect the risk of each bank.

With this disclosure, market discipline replaces regulatory oversight throughout the financial system.

With this disclosure, market participants can hold regulators accountable for doing their job.
Democrats are defending Mr. Geithner, which is consistent with their line since the crisis that every scandal is another excuse to blame the bankers and give even more power to the same regulators who missed or abetted the scandal. 
Clearly, the Wall Street Journal does not think it is a good idea to give more power to the same regulators who missed or abetted each scandal in the financial system.
Pending more evidence, we're inclined to think Mr. Geithner was more right in 2008 than he is now. But if Libor really was a vast criminal enterprise, then regulators need to be held accountable for doing so little about it for so long.
Former SigTARP Neil Barofsky suggested
Geithner and other regulators should be held accountable, they should be fired across the board.  If they knew about an ongoing fraud, and they didn't do anything about it, they don't deserve to have their jobs. I hope we see people in handcuffs. 

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