Rate rigging costs more than money
Here are some depressing figures: 133, 20, 4, 3 and 1. They are the most recent key counts in what might be the most alarming of all the financial scandals since the 2008 crisis, the sometimes successful efforts of traders to rig benchmark rates.
The first four numbers come from Singapore; they count up, respectively the traders, institutions, years and rates involved in attempted manipulation in the city-state. The one is for Tom Hayes, the first and so far only trader to face criminal charges for messing with the Libor interest rate. Investigations of possible unfair play in energy-price benchmarks are continuing, but it is already clear that too many traders in too many markets tried too often to profit by manipulating supposedly objective readings of market conditions.
In cash terms, the machinations are hardly a problem. In comparison to the hundreds of billions lost and the score of institutions capsized by reckless speculation made before the 2008 financial crisis, any losses – the Singapore authorities say that rates there stayed honest – were microscopic. While the distortions of one-hundredth of a percent were large enough to enrich a few traders, they were too small to make anyone else noticeably poorer, or to add much to the profits of the banks which employed the crooked traders.
The ethical and institutional balance is quite different. The small size of the potential gains reduces the role of intoxicating greed. Greed led banks into risky transactions which seemed to promise huge gains, and helps explain why bosses were not vigilant about rogue traders as long as the rule-breaking produced profit. Greed is not good, but it does less social damage than sober dishonesty. And institutional dishonesty is the best explanation for the tolerance of behaviour which brings such small gains and so much reputational damage. The financial industry suffered from the moral equivalent of total tone-deafness.
The provision of financial benchmarks is basically a sort of public service. These reference rates allow economic actors – borrower and lenders, buyers and sellers – to take advantage of the ability of financial markets to determine a fair price without the inconvenience that comes with actual market transactions.
For example, daily renegotiation of the interest rate on a corporate loan would be time-consuming and fairly expensive. However, by combining the Libor benchmark – the rate banks would charge each other for overnight loans – with a company-specific risk premium, such floating-rate debts can be arranged easily. Similarly, it is much easier to set the price of many shiploads of oil with a suitably adjusted benchmark than to sell each shipload individually.
The ethics come in because the benchmarks are typically agreed by traders rather than set in an open market. That may sound weird, but each sale has its own special conditions. No single transaction is as representative of actual market conditions as the collective judgment of honest traders. And that’s the rub. The traders were not honest. The public were not served.
A refined moral sensibility was not required to consider this behaviour unacceptable. Even a crude concern for reputation would have sufficed. The public may not understand what benchmarks do, but they know that lying in a matter of trust is wrong. However, the ethical culture of traders’ employers was so flawed that they were slow to attack cheating in an economically trivial but symbolically important business.
Customers might want to boycott every bank, broker and trading house which let the bad behaviour fester, but the problem was pervasive. Few big firms have not been accused, and I am waiting to see evidence of any institution which was repulsed by benchmark rigging on principle.
Indeed, I would love to see a paper trail of virtue – the internal investigations of excess profit and lavish entertainment in what should be marginally profitable businesses, the indignant presentation of suspicions to trade groups, the complaints filed to regulators and the public shaming of miscreants. I do not expect that desire to be satisfied.
I argued a few weeks ago that the financial culture has become too aristocratic: arrogant, isolated and ridiculously lucrative. But it is having trouble living up to one of the more appealing parts of the aristocratic tradition: a strong code of honour.
True, honour has always played an important role in the financial business. The motto of the London Stock Exchange – my word is my bond – expresses it well. The virtue, however, is easily forgotten when insiders can easily get away with cheating outsiders. There has been so much of that in finance – from banks which agree to charge usurious interest rates to brokers who front-run trades – that the industry’s history can be told as a long fight between honourable and shameful behaviour. The prevalence of benchmark rigging suggests the wrong side has been winning.