Opinion

Alison Frankel

After Libor, arguments against financial regulation are a joke

By Alison Frankel
December 19, 2012

Everyone who has ever claimed that the financial industry is overregulated should be forced to read the final notice on UBS’s manipulation of the London interbank offered rate issued Wednesday by the United Kingdom’s Financial Services Authority.

UBS disclosed its cooperation with antitrust authorities more than a year ago, so it’s no surprise that the bank was penalized, though the size of the penalty – a total of $1.5 billion to United States, UK and Swiss regulators – was certainly notable, particularly because UBS had been granted leniency for some parts of the Libor probe. But what’s most striking about the FSA’s filing on UBS, just like its previous notice on Barclays, is the brazenness of the misconduct the report chronicles. According to the FSA, 17 different people at UBS, including four managers, were involved in almost 2,000 requests to manipulate the reporting of interbank borrowing rates for Japanese yen. More than 1,000 of those requests were made to brokers in an attempt to manipulate the rates reported by other banks on the Libor panel. (Libor rates, which are reported for a variety of currencies, average the borrowing rates reported by global banks; 13 banks are on the yen panel.)

The corruption was breathtakingly widespread. According to the FSA, UBS took good care of the brokers who helped the bank in its rate-rigging campaign: Two UBS traders whose positions depended on Libor rates, for instance, engaged in wash trades to gin up “corrupt brokerage payments … as reward for (brokers’) efforts to manipulate the submissions.” In one notorious 2008 phone conversation recounted in the FSA filing, a UBS trader told a brokerage pal, “If you keep (the six-month 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.”

According to the FSA, the bank’s rate manipulation, whether to improve UBS’s trading positions or to protect the bank’s image, was so endemic that one flummoxed rate submitter complained in 2007 of being caught between demands by two different traders who wanted two different fake submissions. “I got to say this is majorly frustrating that those guys can give us shit as mu c h as they like…. One guy wants us to do one thing and (the other) wants us to do another,” he told a UBS manager, according to the FSA. Even after The Wall Street Journal first broke news of suspected Libor manipulation in 2008, UBS managers discussed continuing their rate-rigging, this time with the goal of staying in the middle of the pack of rate reports so it would look as though they weren’t engaged in rigging.

UBS and Barclays, moreover, weren’t outliers, according to the FSA. Since Libor rates are averaged, the banks had to collude with other panel banks to affect the reported rates. The FSA filings indicate that they did. The same UBS trader who rewarded brokers with fees for wash trades, for instance, supposedly entered into trades with the specific purpose of aligning his position with those of traders at other panel banks so that they could all share in the benefits of rate-rigging. “UBS’s misconduct,” the FSA said Wednesday, “extended beyond UBS’s own internal submission processes to sustained and repeated attempts to influence the submissions of other banks, acting in collusion with panel banks and brokers at a number of different broker firms.”

The victims of the manipulation, of course, were all of the people who assumed the legitimacy of Libor benchmarks, which are used to set interest rates on trillions of dollars of loans around the world. I’m not even talking about the money damages sought by antitrust plaintiffs in the United States, who have claimed that Libor and Euribor price-fixing conspiracies resulted in interest-rate overpayments. Their actual damages, if there are any, will be hashed out in litigation. I’m speaking more broadly about the borrowing public that took out loans pegged to Libor rates because they believed those rates were set honestly. How many small businesses and homeowners had any idea that traders from UBS and Barclays were promising rewards to colleagues who agreed to lie about borrowing rates to benefit the banks’ trading positions? And how many of those cheating bankers ever thought about the borrowers who would be affected by their rate-rigging?

In that regard, the Libor cases share a theme with the other great scandals exposed in the years since the financial crisis: Insiders will blithely compromise market integrity for their own profit, and we, the uninformed public, are their dupes. Consider Citigroup and Goldman Sachs, which both agreed to settlements with the Securities and Exchange Commission for deceiving investors about collateralized debt obligations. They created complex financial instruments to rid themselves of exposure to toxic mortgage-backed securities, then dumped those CDOs on investors who weren’t as shrewd. Sure, the banks (and some judges) have noted the relative sophistication of investors in those CDOs, but if you contributed to a pension fund that bought CDOs from a bank secretly betting on the failure of those instruments, you’re a victim.

So too are MBS investors who counted on issuers’ representations and warranties. We now know the securitization business was fundamentally flawed, with legions of homeowners approved for mortgages they couldn’t possibly pay and untold thousands of investors fed lies about who those borrowers were. You can argue that borrowers share the blame for agreeing to take out unaffordable loans, but that doesn’t excuse issuers from responsibility for misrepresenting facts about the loans when they bundled up mortgages and created MBS trusts. As we’ve seen in case after case, banks knew the loans were deficient yet told investors otherwise. In some instances, they even received compensation from mortgage originators for deficient loans, but kept the money for themselves instead of passing it on to investors.

If we’ve learned nothing else in the last four years, we should at least acknowledge that some people within financial institutions, if left to their own devices, will behave dishonorably and even illegally. The drive for profits in people like the UBS traders and their brokerage conspirators, as described in the FSA filing, is obviously more powerful than any qualms about morality or fear of being found out.

That’s why moaning about Dodd-Frank whistle-blowers or duplicative actions against the banks rings hollow. Insiders will abuse the power of asymmetry: They know about their own secret conduct and we don’t. We’re playing by their house rules, and regulators armed with subpoenas are the only hope we’ve got.

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