Over the next few days I will be involved in transferring some of the major IT infrastructure for my research centre from our Newcastle office to our Melbourne office. This is the first stage of our plan to virtualise our server capacity – reducing costs, making it easier to manage, and giving us more independence in our new multi-campus structure. Sounds like fun doesn’t it. Not! It also wasn’t much fun reading the documents published by the UK Financial Services Authority (FSA) and the US Department of Justice last week concerning their investigations into the UBS LIBOR manipulation scandal. We read of widespread criminality and a total disregard for ethics and values. The authorities have, however, seen fit to go soft on the bank and will prosecute only a few it seems when many were involved. The point is that this is not the isolated act of a rogue trader or two. Criminality and greed is embedded in the culture of the financial sector and only major reform will get rid of it. That reform should start with the withdrawal of the license of USB to operate and then progressively the outlawing of the derivatives market and the scaling back of what banks can legally be involved in. Such major reform will not happen but until we get close to it the bad boys will continue to run loose.
The title of today’s blog is in reference to an exchange between a UBS trader and a broker as reported in the – UBS Statement of Facts – issued by the US Justice Department:
mate yur getting bloody good at this libor game . . . think of me when yur on yur yacht in monaco wont yu
Last week (December 20, 2012), the Australian Institute of Health and Welfare (a Federal government research agency) published a report – Juvenile detention population in Australia 2012 – which showed that in the June-quarter 2012 “just over half (53%) of all those in detention were Indigenous”.
These are young people aged between 10 and 17 years. Our indigenous population overall is about 2 per cent of the total general population.
The AIHW Report also found that “Over the 4-year period (June quarter 2008 to June quarter 2012)” the:
… numbers of young people in detention on an average night were stable … [but] … the Indigenous to non-Indigenous rate ratio increased from 27 to 31 times, with most of the change occurring in the most recent year …
The imprisonment rates for indigenous adult in Australia is also highly disproportionate and the sentences for similar offences appear to be harsher for indigenous offenders.
For example, in the past month I have had meetings with government officials in the Northern Territory (Darwin) about various projects. One of the issues that arises is that the remote indigenous communities are poorly serviced in terms of basic governmental services. An example, is that in some areas it is hard to acquire a driving license without travelling hundreds of kilometres (on poor roads which are often impassable in the wet season) to some larger centre.
Result – the temptation to drive without a license increases especially given the distances that are required to be transacted in remote areas for basic activities.
A recent study by the NSW Aboriginal Legal Service found that:
ABORIGINAL offenders convicted of driving while disqualified in remote and regional NSW are being sentenced to jail at three times the state average … The study … showed that not only were jail sentences for indigenous people handed out more often, but they were also for longer than the state average … A large number of Aborigines , who are grossly over-represented in the prison system, are serving sentences for petty offences or what the ALS describes as “poverty offences” such as driving while disqualified.
This is a common problem right across remote Australia.
In my spare time, I also have been watching some of the documentaries produced by Louis Theroux about prison systems in the US. The excellent – ABC i-view service – allows characters like me to defer our consumption of TV to times that are suitable (like early mornings).
The two-part program on the Miami penal system was horrifying to say the least. It suggests that once you fall foul of the law in that jurisdiction you enter a system that virtually ensures you remain in it. The prisons (even the remand centres) were portrayed as highly effective training centres for criminal skill development.
The same is the case everywhere in the world – more or less. The disadvantaged become locked into a spiral that is hard to exit.
The US – Three Strikes Law – entraps criminals who commit felonies into a life of imprisonment with very little room for salvation.
But as we know, the application of the law is very uneven across income and wealth cohorts in most nations. This is clearly evident in the way the US and UK governments have handled the UBS scandal.
The US Department of Justice announced last week that the bank (its Japanese subsidiary) would plead guilty – NOTICE – to felonious behaviour where they manipulated – London Interbank Offered Rate (LIBOR) – benchmark interest rates over many years.
According to the Bank of International Settlements (BIS) the “notional amount of over-the-counter interest rate derivative contracts was valued at approximately $450 trillion” in the last 6 months of 2009. The LIBOR is the “benchmark interest rate” for settlement of these contracts. Futher, the LIBOR is often used as the reference rate for “mortgages, credit cards, student loans, and other consumer lending products”.
For those not familiar with the LIBOR, it is published by the – British Bankers’ Association – which is “the leading trade association for the UK banking and financial services sector” with “over 200 member banks from 60 countries”.
Its board is made up of senior executives from the big banks and it aims to “engage with government, devolved administrations and Europe as well as the media and other key stakeholders to ensure the industry’s voice is heard”. In other words it is a lobbying organisation and has been a force in the deregulation of the financial sector in Britain.
The – LIBOR – is defined as:
The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11.00am London time.
The rate is “an indication of the average rate at which a LIBOR contributor bank can obtain unsecured funding in the London interbank market for a given period, in a given currency” and is computed after “submissions from LIBOR contributor banks, which are then averaged under a “trimmed mean” methodology”.
So every “contributor bank is asked”:
At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?
The BBA note that the LIBOR is “not necessarily based on actual transactions, as not all banks will require funds in marketable size each day in each of the currencies/ maturities they quote and so it would not be feasible to create a full suite of LIBOR rates if this was a requirement”.
Now we know that there is an additional reason why the LIBOR is not based on actual transactions or market conditions.
The – UBS Statement of Facts – issued by the US government is a sorry tale indeed.
The scandal also extends to the Euro Interbank Offered Rate (Euribor) – the reference rate overseen by the European Banking Federation – and the Euroyen Tokyo Interbank Offered Rate (TIBOR), which is the reference rate overseen by the Japanese Bankers Association.
The US Justice Department said that these benchmark rates “play a fundamentally important role in financial systems around the world”.
We now know that:
Beginning in 2006, in Zurich, Tokyo, and elsewhere, several UBS employees engaged in sustained, wide-ranging, and systematic efforts to manipulate Yen LIBOR and, to a lesser extent, Euroyen TIBOR, to benefit UBS’s trading positions. This conduct encompassed hundreds of instances in which UBS employees sought to influence benchmark rates; during some periods, UBS employees engaged in this activity on nearly a daily basis.
The official inquiry documents are full of lurid conversations and E-mail interchanges between the various criminals – which not only record their conspiracy but also demonstrate that these characters are rather primal (uncouth) and are seriously tested by basic English spelling skills.
There were multiple trading techniques used to manipulate the market illegally to the benefit of the bank and those within it who were receiving tens of thousands of dollars in commissions each month.
The US Justice Department estimate that the US government housing agencies – Fannie Mae and Freddie Mac – are among those damaged by the manipulation. The estimate is that they lost more than $3 billion because of the criminal behaviour of UBS and others.
The list of victims will expand. But who benefited? A narrow group of over-paid traders and managers in the banks concerned. The US Attorney General said that behaviour “defrauded the company’s counterparties of millions of dollars. And they did so primarily to reap increased profits, and secure bigger bonuses, for themselves”.
There are so many lurid exchanges documented. The one getting most attention is a transcript of a telephone conversation on September 18, 2008 between a trader and a broker. It related to what the British FSA called a “wash trade … i.e. risk free trades that cancelled each other out and which had no legitimate commercial rationale” (Source: Final Notice for UBS AG):
… if you keep 6s [i.e. the six month JPY LIBOR rate] unchanged today … I will fucking do one humongous deal with you … Like a 50,000 buck deal, whatever … I need you to keep it as low as possible … if you do that …. I’ll pay you, you know, 50,000 dollars, 100,000 dollars… whatever you want … I’m a man of my word …
In their – Final Notice for UBS AG – we learn that UBS was making “corrupt payments of £15,000 per quarter to Brokers to reward them for their assistance”.
The arrogance of those involved is captured by the names they gave themselves (as reported by the FSA):
“the three muscateers [sic]”, “SUPERMAN”, “BE A HERO TODAY” and “captain caos [sic]” …
The criminals also guided so-called “honest banks” to move submissions in a certain direction. They said “hopefully the sheep will just copy”. The disdain is evident in their terminology.
The evidence is now clear – the Bank had clearly indulged in criminal behaviour. However, according to the – UBS Non-Prosecution Agreement – the:
… the United States Department of Justice, Criminal Division, Fraud Section (“Fraud Section”) will not criminally prosecute UBS AG and its subsidiaries and affiliates (collectively, “UBS”) … for any crimes … related to UBS’s submissions of benchmark interest rates, including the London InterBank Offered Rate (known as LIBOR), the Euro Interbank Offered Rate (known as EURIBOR), and the Tokyo InterBank Offered Rate (known as TIBOR) …
Why? Apparently, UBS has been a cooperative criminal and promises not to do it again. The US Justice Department also claimed that imposing criminal charges on the Bank would endanger financial stability.
A few individuals are being prosecuted only. The authorities could withdraw the license to operate from UBS and there would be no danger to financial stability. There could also be safeguards on the deposits put in place without any issue.
In the “Deferred Prosecution Agreement” we learn that:
UBS executives knew that UBS’s cross-border business violated the law … They refused to stop this activity, however, and in fact instructed their bankers to grow the business. The reason was money — the business was too profitable to give up. This was not a mere compliance oversight, but rather a knowing crime motivated by greed and disrespect of the law.
Across the Atlantic, the British Financial Services Authority (FSA) issued a press release on December 19, 2012 – UBS fined £160 million for significant failings in relation to LIBOR and EURIBOR – which relates to the same LIBOR manipulation in the UK jurisdiction.
The FSA concluded that the UBS “misconduct was extensive and widespread” and involved “traders, managers and senior managers”. They join Barclays among those already outed but the list of major global banks that are implicated in the criminality will expand.
Several things need to be understood here.
First, the vast proportion of the transactions (“trades”) that are involved here are unproductive – in the sense they add nothing to our real standard of living.
Please read my blog – Financial markets are mostly unproductive – for more discussion on this point.
Financial markets are, in the most part, unproductive and produce very little of any value to the broader community. That is at the best of times. But the recent crisis has demonstrated that when they over-extend they have lethal consequences for the real economy.
People and nations now suffering unemployment, poverty, and, in some cases, starvation, had nothing to do with the development of all the shady products that the geniuses on Wall Street invented and pushed often fraudulently, onto ignorant investors.
Further, if private cost-benefit is to be the arbiter of where activity is best focused then a significant number of projects that obviously generate social wealth would never be funded. Society would be much worse off as a consequence. I can think of countless examples where the private markets would never have provided a socially-beneficial activity or resource.
In other words, there is a serious flaw in the proposition that financial markets are the best judges of social costs and benefits. Even mainstream microeconomics textbook have sections (if you can find them) on the divergence between social and private calculations and the need for non-market interventions to resolve the differences.
A study from WIFO (Austrian Institute for Economic Research) – A General Financial Transaction Tax: A Short Cut of the Pros, the Cons and a Proposal – traced the explosion of global financial flows and derivative markets in the period leading up to the financial crisis.
WIFO made two general observations:
- The volume of financial transactions in the global economy is 73.5 times higher than nominal world GDP, in 1990 this ratio amounted to “only” 15.3. Spot transactions of stocks, bonds and foreign exchange have expanded roughly in tandem with nominal world GDP. Hence, the overall increase in financial trading is exclusively due to the spectacular boom of the derivatives markets …
- Futures and options trading on exchanges has expanded much stronger since 2000 than OTC transactions (the latter are the exclusive domain of professionals). In 2007, transaction volume of exchange-traded derivatives was 42.1 times higher than world GDP, the respective ratio of OTC transactions was 23.5% …
In other words, most of the financial flows comprise wealth-shuffling speculation, transactions which have nothing to do with the facilitation of trade in real goods and services across national boundaries.
In some cases, transactions that involve hedging and speculation are beneficial if they facilitate trade flows and provides security to a trading company. When we talk about hedging in this context we are referring to a strategy to avoid foreign exchange risk (sometimes called covering an open position).
Please read my blog – A global financial tax? – for more discussion on this point.
The important point is that the risk is transferred to the speculator and it is likely that arrangements like this increase the volume of international trade because the trading firm bears none of the risk of the exchange rate exposure involved in the cross-border transactions. In this context, the speculative behaviour helps to facilitate trade in real goods and services which improves material standards of living (in general).
But that sort of transaction is a very small proportion of the total volume of financial transactions that occur on any single day.
The Over the Counter (OTC) derivatives market has long been a source of contention. In the US, regulators who sought to regulate the growing and secretive OTC derivatives market were met with great resistance from the likes of Robert Rubin, Alan Greenspan and Larry Summers. The latter three were touted as the “Committee that Saved the World” by Time Magazine on February 15, 1999.
Please read my blog – Being shamed and disgraced is not enough – for more discussion on this point.
Similarly, the British labour government coined the term “soft regulation” which mean virtually none and what there was left would be applied loosely. The result – the banking disasters we have witnessed.
The other point to note is that the funds that the wealth-shufflers are playing with and cheating each other have ultimately come from major redistributions in real income to profits and away from wages.
A characteristic of the neo-liberal era has been the concerted effort by capital to suppress real wages growth and allow the gap between it and productivity growth to widen, thus redistributing real national income away from wages.
While this presented a realisation problem – who would consume the increasing production – the answer was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments.
This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers. T
he financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold.
And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
The largesse also allowed these investment banks (a misnomer if there ever was one) to garner the kitties they required to engage in their derivative trading.
Then the criminal greed took over and we have the sort of behaviour that has been revealed in the most recent UBS reports.
Please read my blog – The origins of the economic crisis – for more discussion on this point.
We often hear of the term “rogue trader” as the characterisation of the problem. In the decade or so before the financial crisis, as the financial sector was growing rapidly as governments relaxed regulations and watered down the oversight functions, there were scandals but these were typically dismissed with the “rogue trader” defense.
What we now know is that there is a culture of deceit and criminality that permeates the sector as a whole. There are many rogues.
Given that most of this behaviour is of no consequence to the material standards of living of most of us on a daily basis but can cause severe damage to those standards when a crisis emerges, I prefer the line of argument that was outlined in this Bloomberg Op Ed (December 24, 2012) – UBS Libor Manipulation Deserves the Death Penalty – which concludes that:
There is no point in mincing words: UBS AG (UBSN), the Swiss global bank, has been disgracing the banking profession for years and needs to be shut down … an even more emphatic message needs to be sent to UBS by its prudential regulator in the U.S.: You are finished in this country. We are padlocking your Stamford, Connecticut, and Manhattan offices. You need to pack up and leave. Now.
The article documents a litany of UBS-related scandals over a number of years that are separate from the LIBOR manipulation. For example, on February 18, 2009, we learned that – UBS Enters into Deferred Prosecution Agreement – which related to the Bank laundering money for US citizens so that they could avoid their tax obligations.
From an Modern Monetary Theory (MMT) perspective, the only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers. Attention should always be focused on what is a reasonable credit risk. In that regard, here is a sketch of what I would do with the commercial banks by way of regulation.
Banks should only be permitted to lend directly to borrowers. All loans would have to be shown and kept on their balance sheets. This would stop all third-party commission deals which might involve banks acting as “brokers” and on-selling loans or other financial assets for profit. It is in this area of banking that the current financial crisis has emerged and it is costly and difficult to regulate. Banks should go back to what they were.
Banks should not be allowed to accept any financial asset as collateral to support loans. The collateral should be the estimated value of the income stream on the asset for which the loan is being advanced. This will force banks to appraise the credit risk more fully.
Banks should be prevented from having “off-balance sheet” assets, such as finance company arms which can evade regulation.
Banks should never be allowed to trade in credit default insurance. This is related to whom should price risk.
Banks should be restricted to the facilitation of loans and not engage in any other commercial activity.
In other words, closing the OTC markets would be a preferable step.
As is clear – the white collar criminals typically get away with it while the most disadvantaged among us pay for every little misdemeanour. The system is stacked against those with the least.
The bad boys in the financial sector tend to get away with their criminality.
Now to matters IT.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.