On June 27, Barclays, the U.K.’s second-largest bank by assets, admitted that it deliberately reported artificial borrowing costs from 2005 to 2009. The false reports were used to set a benchmark rate, the London interbank offered rate, or Libor, which affects the value of trillions of dollars of derivatives contracts, mortgages, and consumer loans. The bank agreed to pay a hefty $455 million to settle charges with U.S. and U.K. regulators.
Libor and its euro counterpart, the Euribor, are benchmark rates determined by banks’ estimates of how much it would cost them to borrow from one another, in different time frames and currencies. The banks submit sheets of numbers every weekday morning, London time. An adjusted average of the rates determines the size of payments on mortgages and corporate loans worldwide. The rates also serve as an indicator of the health of the banking system. Because some submissions aren’t based on real trades, the potential exists for manipulation.
The Libor system, overseen by the British Bankers Association, operates much the way it did in the 1980s. Even after the news media uncovered evidence of manipulation in 2008, the bank lobby did little to reduce conflicts or improve the veracity of its numbers.
Heads should roll at other banks, too. Regulators and criminal prosecutors, including officials at the U.S. Department of Justice, are investigating at least a dozen other firms to determine whether they colluded to rig the rate. Among them: Citigroup, Deutsche Bank (DB), HSBC Holdings (HBC), and UBS (UBS).
Run properly, big banks have just as much a right to exist—and thrive—as any other corporate entity. But it’s difficult to defend an industry that defrauds the market with fake interest rate figures, thereby stealing from other banks and customers. The Libor case reveals something rotten in today’s banking culture. And we hope the investigations will expose the bad actors, lead to jail terms for those who knowingly manipulated the market, and force out the senior managers and board directors who participated in or overlooked such conduct.
In the Barclays settlement documents, regulators released smoking-gun e-mails that reveal the extent of the dirty dealing between bank traders (looking to protect profits and bonuses) and senior officials in bank treasury units (hoping to convince markets that their banks weren’t in financial difficulty). The two aren’t supposed to collude, but it’s obvious that the Chinese walls between them come with ladders.
The real tragedy of the scandal is the apparent lack of ethics or self-restraint among the people involved. Following billions of dollars of trading losses at JPMorgan Chase’s (JPM) out-of-control London unit, the latest installment of the Big Bank Follies offers yet more proof that the industry shouldn’t be trusted to regulate itself.
Big Bank Collusion is not new.
Taylor Caldwell, author of the bestseller "Captains and The Kings" in 1972, warned the Baby Boomers of the need for their grassroots leadership in her book's Forward:
"This book is dedicated to the young people of America, who are rebelling because they know something is very wrong in their country, but do not know just what it is. I hope this book will help to enlighten them. The historical background and the political background of this novel are authentic. The "Committee for Foreign Studies" does indeed exist, today as of yesterday, and so does the "Scardo Society," but not by these names.
There is indeed a "plot against the people" and probably always will be, for government has always been hostile towards the governed."
How do big banks make a profit on government insurance?
On June 28, Richard Fisher, president of the Dallas Federal Reserve, said that the markets assume larger banks are too big to let fail. Five banks—JPMorgan, Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), and Goldman Sachs (GS)—held more than $8.5 trillion in assets at the end of 2011, equal to 56 percent of the U.S. economy, according to the Federal Reserve.
Fisher also pointed out that this assumption lowers borrowing costs for those banks, which he called an “unfair subsidy.” By one estimate, between 2007 and 2010, simply being too big to fail saved America’s biggest banks a combined $120 billion in lower borrowing costs. Citigroup saved some $50 billion. And even with its fortress balance sheet, JPMorgan saved $10 billion thanks to its size and importance.
The estimate comes from a paper Frederic Schweikhard and Zoe Tsesmelidakis presented in late May to a New York University Stern School of Business conference on credit risk. The pair, both Ph.D. candidates at Goethe University Frankfurt, relied on a well-tested tool of finance—the Merton model of pricing corporate debt—to come up with their estimate.
The Merton model is tricky to understand. Luckily Robert Merton, a Nobel laureate now at Massachusetts Institute of Technology’s Sloan School of Management, answered the phone to help explain it. “Pick up two pieces of paper,” he said, “are you doing it?” Indeed. “Now,” he continued, “label one ‘corporate bond’ and the other ‘full faith and credit of the United States Treasury.’” Put them together and it looks like two slips of paper stacked together. “That’s risk-free debt,” he said, “you’re gonna get paid no matter what.”
The price of every loan, he explained, consists of two pieces: the inconvenience of parting with your money for as long as the borrower needs it, and the risk that the borrower will default before repaying you—which, in the case of the big banks, is eliminated by the Treasury’s implicit guarantee. “Those are different activities. One is the time value of money and the other is insurance,” he said.
Source: Bloomberg BusinessWeek, July 9, 2012
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