What was your immediate reaction when you learned about the manipulation of Libor rates?
My conservative guess is that 90 percent of us shrugged cynically and then said something like, "What a surprise, more shenanigans in the financial services sector."
Besides, the Libor rate seems like a murky figure that many of us foggily relate to macroeconomic trends. It's actually extremely important.
The "London interbank offer" ("Libor") rate "is the primary benchmark for short term interest rates globally and is used as the basis for settlement of interest rate contracts on many of the world's major futures and options exchanges," according to the British Bankers Association (BBA), whose members effectively set the Libor rate. In plainer English, the Libor rate greatly influences the borrowing costs of mortgages, credit cards, student loans and other financial products (roughly $750 trillion worth of financial products.)
"Libor is one of the most important rates in the economy," notes Eduardo Porter in a strong column on corporate corruption. "It determines the return on the savings of millions of people, as well as the rate they pay on their mortgage and car loans. It is the benchmark for hundreds of trillions of dollars worth of financial contracts."
In his column Porter refers to an academic study that concludes that an "economic underground" flourishes when companies have an incentive "to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations."
The study, co-authored by George Akerlof and Paul Romer, examines our spate of financial crises, the government bailout of insolvent banks and a disturbing real estate bubble (one that, in retrospect, defies common sense). Sadly (though not surprisingly, to the cynics among us), the study was published in 1993.
This is not to say that Barclays (which is paying $450 million to settle allegations that its employees manipulated Libor rates) or any of the other large banks under the microscope for similar shenanigans were seeking to loot via bankruptcy. Instead, it appears that the bank(s) manipulated interest rates to A) boost trading profits (an unethical gamble on success with social costs -- your and my rates on financial products may have been negatively and artificially nudged up or down); and/or B) stave off concerns about their financial health/viability during the financial crisis.
The largest cost of the Libor scandal, as with all corporate scandals, is in the cynicism it produces. One of the reasons I personally (and wrongly) shrugged off the Libor scandal news at first was that it appeared as trite as a summer blockbuster sequel to my English-major sensibilities. It had all of the requisite plot points of every other scandal: Large banks break rules to boost profits; public hearings; outrage, calls for tighter/more regulations (followed by the same-old "more regulation will save us vs. more regulation is evil" political debates that completely miss the mark and provide absolutely no progress toward progress).
The Libor news even included the standard Outrageous Email that convinces us that some (or many) of the bank's employees don't have an ethical bone in their bodies: "The most pointed evidence that breaking the rules has become standard behavior in the corporate world," writes Porter, "is how routine the wrongdoing seems to its participants. ‘Dude. I owe you big time!... I'm opening a bottle of Bollinger,' e-mailed one Barclays trader to a colleague for fiddling with the rate and improving the apparent profit of his derivatives book."
At the risk of sounding like a broken record, why don't more risk-management frameworks contain a cultural or behavioral box? How do the actual decisions, behaviors, unspoken pressures and other intangible yet extremely influential elements of our culture jibe -- or not -- with our risk management policies and processes?
The reason more companies backed by government guarantees (and/or too-big-to-fail companies whose individuals have the power to influence systemic risk, if they so choose) do not choose to loot via bankruptcy is because their leaders and culture actually buy into long-termism: they believe that it is more profitable to profit over time than to profit all at once.
Dude, where is the risk management capability that effectively addresses the softer factors that deliver the hardest blows to shareholders and stakeholders?