Thursday, February 28, 2013

Despite Lord Turner's claim, it was not impossible to spot Libor manipulation

Reuters reports that in his testimony before the Parliament Commission on Banking Standards, Lord Turner, the head of the UK's Financial Services Authority, asserted that it was impossible to have had a police force big enough to spot the manipulation of Libor.

This statement is false and underscores why bank regulators by themselves will never be up to the task of policing the financial system.

Had the banks been required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, there would have been a police force big enough and motivated enough to spot manipulation of Libor and other benchmark interest rates.

Even if Libor and the other benchmark interest rates had been compiled in an opaque manner, market participants could still have double checked what the interest rates against the actual transactions entered into by the banks.

A discrepancy between the benchmark interest rates and what was actually occurring would have been noticed.

Why would market participants have been looking to see if there was a discrepancy between the benchmark interest rates and the transactions the banks actually engaged in?

Because the market participants who had an exposure to Libor and the other benchmark interest rates had a financial incentive to do so.

Regular readers know that the global financial system is based on the FDR Framework which combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

This framework provides a much bigger police force than just the financial regulators as every market participant has an incentive to look out for themselves.

One of the causes of our current ongoing financial crisis is the regulators' information monopoly when it comes to financial institution.  It was and still is only the financial regulators who have access to all the useful, relevant information for assessing the banks.

What the manipulation of the benchmark interest rates and the financial crisis have shown is that the financial regulators are not up to the task of replacing the market and all of its participants when it comes to policing the banks.

Since the beginning of the financial crisis, I have repeatedly said that the financial regulators should give up their information monopoly, require the banks to provide ultra transparency and then piggyback off of the market's ability to both analyze the banks and to enforce discipline on the banks.

There is a role for financial regulators.  It is just not as a replacement for the market.  It is as a second line of defense should market participants fall prey to some popular delusion.

Regulators could not have spotted the "lowballing" of Libor interest rates during the financial crisis even if they had looked, Britain's Financial Services Authority said.
But financial market participants could and more importantly would have if they had access to each bank's exposure details.
The watchdog's chairman, Adair Turner, told a parliamentary commission on banking standards on Wednesday it was much easier to see abuses in share trading by using computers.
Same computers could have spotted Libor manipulation.  What is required is that the computers have the actual transaction data.
Manipulation of the London interbank offered rate (Libor) during the 2008 crisis, for which three banks - Barclays BARC.L, Royal Bank of Scotland and UBS - have been fined so far was far harder to see, he said. 
"There was no information on the trader manipulation," Turner told the commission....
There was no information disclosed to the market that would allow it to discover that traders were manipulating the benchmark interest rates.

The regulators had and still have a monopoly on the information that would have shown that the rates were being manipulated.  It is only the regulators who have access to each bank's current global asset, liability and off-balance sheet exposure details.

The fact that the regulators were not up to the task of discovering the interest rate manipulation even after they had been told about it (see NY Fed and Tim Geithner), does not mean that the market would not have discovered it.
Neither the FSA, the CFTC - two of the regulators that have fined the three banks - or other regulators had ways to see the trader manipulation, Turner said. "We could not have got at it by intensive supervision. You just cannot have a police force big enough to spot all these problems."
When the banks are required to provide ultra transparency, there is a plenty big enough police force as every participant in the market has an incentive to police the banks.
While whistleblowing was one of the few ways to report illegal activity, Turner said trading room mentality was detached from the real economy as some traders see their job in front of a screen as being like playing a computer game, asking "Why shouldn't I cheat?".
With banks being required to provide ultra transparency, the answer to why shouldn't I cheat is because I will be caught! 

There is a reason that sunlight is the best disinfectant!

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