The magnitude of the banking scam must be realised and tough action taken
The UBS building in Zurich. Photograph: Michael Buholzer/Reuters
This is the year the consensus changed. Around the world,
policy-makers, regulators and bankers recognised that the legacy of the
20-year credit boom up to 2008 is more corrosive than all but a few
realised at the time. The bankers – and the theorists who justified
their actions – made a millennial mistake. Navigating a way out of the
mess was never likely to be easy, but it is made harder still by not
recognising the magnitude of the disaster and the necessary radicalism
involved if things are to be put right.
If there were any last doubts they were dispelled by the record $1.5bn fine paid by the Swiss bank UBS for "pervasive" and "epic" efforts to manipulate the benchmark rate of interest – Libor
– at which the world's great banks lend to each other. The manipulation
was at the behest of the traders who buy and sell "interest rate
derivatives", whose price varies with Libor, so that cumulatively
billions of pounds of profits could be made. Nor was UBS
alone. What is now evident is that all the banks that made the daily
market in global interest rates in 10 major currencies were doing the
same to varying degrees.
There was a complete disdain for the
banks' customers, for the notion of custodianship of other people's
money, that was industry wide. It is hard to believe this culture has
evaporated with the imposition of a fine. No banker falsifying the
actual interest rates at which he or she was borrowing or lending, or
trader who requested that they did so, had any sense that there is
something sacred about banking – that the many billions flowing through
their hands are not their own. It was just anonymous Monopoly money that
gave them the opportunity to become very rich. The UBS emails, which
will be used to support criminal charges, could hardly be more
revealing. This was about making money from money for vast personal
gain.
Interest rate derivatives are presented as highly useful if
complex financial instruments – essentially bets on future interest rate
movements – that allow the banks' customers better to manage the risks
of unexpected movements in interest rates. Whether a multinational or a
large pension fund, you can buy or sell a derivative so you will not be
embarrassed if suddenly interest rates jump or fall. Bookmakers lay off
bets. Interest rate derivatives allow buyers to lay off the risk that
their expectations of interest rate movements might be wrong.
What
makes your head reel is the size of this global market. World GDP is
around $70tn. The market in interest rate derivatives is worth $310tn.
The idea that this has grown to such a scale because of the demands of
the real economy better to manage risk is absurd. And on top it has a
curious feature. None of the banks that constitute the market ever loses
money. All their divisions that trade interest rate derivatives on
their own account report huge profits running into billions. Where does
that profit come from?
The answer is it comes largely from you and
me. Global banking, intertwined with the global financial services and
asset-management industry, has emerged as a tax on the world economy,
generating much activity and lending that has not been needed, but whose
purpose is to make those who work in it very rich. The centre-left
thinktank IPPR reports that
people with identical skills earn on average 20% more in financial
services than in other industries, with the premium rising the higher
the seniority. That wage premium does not come from virtuous hard work
or enterprise. It comes from how finance is structured to deliver
excessive profit.
Scandalous
The Libor scam is an object lesson in how
finance taxes the rest of the economy. Plainly, the final buyers of the
mispriced interest rate derivatives could not have been other banks,
otherwise they would have lost money and we know that they all made
profits. In any case, they were part of the scam. The final buyers of
the mispriced derivatives were their customers. Some must have been
large companies, but many were those – ranging from insurance companies
and pension funds to hedge funds – who manage our savings on our behalf.
Here
a second scam kicks in. One of the puzzles of modern finance is why the
returns to those who buy shares in public stock markets are so much
lower than the profits made by the companies themselves. One of the
answers is that there are so many brokers, asset managers and
intermediaries along the way all taking a cut. Sometimes it is through
excessive management fees, but another way is not doing honest to God
investing – choosing a good company to invest in and sticking with it –
but through churning people's portfolios or unnecessarily buying
interest rate derivatives to protect against interest rate risk, while
charging a fee for the "service". Many of those mispriced interest rate
derivatives will have ended up in the investment portfolios of large
insurance companies and pension funds or, more sinisterly, in the
portfolios of the banks' clients.
Most rotten
Bank managements
are presented as ignorant dolts, fooled by rogue traders. They were no
such thing. The interest rate derivative market is many times the scale
than is warranted by genuine demand precisely because it represented
such an effective way of looting the rest of us. The business model of
modern finance – banks trading on their own account in rigged derivative
markets, skimming investment funds and manipulating interbank lending,
all to underlend to innovative enterprise while overlending on a
stunning scale to private equity and property – is not the result of a
mistake. It represents a series of choices made over 30 years in which
finance has progressively resisted any sense it has a duty of
custodianship to its clients or wider responsibilities to the economy.
It was capitalism allegedly at its purest. We now understand it was
capitalism at its most rotten. It needs wholesale reform.
The
government's proposals to ringfence investment banking from the rest of a
bank's activities, following the proposals from Sir John Vickers, is a
start. But it is only that. Last week, Conservative MP Andrew Tyrie's
cross-party parliamentary commission proposed " electrifying" the ringfence with
the threat of full separation if malpractice continues. It also
considered banning banks from trading in derivatives on their own
account. But while tough, the commission should extend its brief. The
issue is to create a financial system in its entirety that serves
individuals and business alike, makes normal profits and, above all,
embeds its public duty of custodianship in the bedrock of what it does.
The government fears that more upheaval will unsettle banking and
business confidence. It could not be more wrong. Reform is the platform
on which a genuine economic recovery will be built.
Comment by Will Hutton - Guardian
Related posts:
The Libor fuss!
Libor scandal blows to British banking system
Anarchy in the financial markets!
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Showing posts with label Interes rate-fixing. Show all posts
Showing posts with label Interes rate-fixing. Show all posts
Wednesday, 26 December 2012
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