As the "LIBOR scandal" continues to unfold, it appears that Barclays Bank may not be the only major financial institution that manipulated LIBOR (London Inter-Bank Overnight Rate). While Barclays recently settled out of court in late June for $450 million, other major banks may also be caught up in this unethical and illegal behavior.

The Economist has pointed out that this could be the "Big Tobacco" moment for the banking industry. That is, as more information comes to light regarding the manipulation of LIBOR, populist anger may continue to foment, and severe punitive actions may be taken against the financial industry. These measures will be not without good reason, based on an estimated $1 trillion worth of contracts affected by LIBOR, including home mortgages and other consumer loans.

While some may point to the LIBOR scandal as being fairly inconsequential to the industry and the economy as a whole in terms of dollars, I would argue that it is further proof that the financial sector's culture remains unscrupulous and unethical. Unfortunately, misguided public policy may also be contributing to this hubris.

Luigi Zingales, a professor of economics at the University of Chicago, has written a timely book, A Capitalism for the People, that provides great insight into the current state of American capitalism. Having grown up and been exposed to Italian crony capitalism, Zingales is all too aware of the disincentives inherent in economies that reward individuals based solely on nepotism and favoritism rather than on meritocratic achievements. Zingales argues that historically, the American style of capitalism has been an engine for growth because of broad based civic support of an underlying premise: that rewards should be commensurate with the risks taken.

Zingales points out that Americans continue to accept wealth disparities and unequal outcomes as long as equal opportunities for success are available. To that end, a social contract was developed whereby investments were made in our public infrastructure, including schools and roads, while a sizeable social safety net continues to provide some cushion for those less fortunate. These social investments help ensure that each citizen is provided with ample opportunity to excel, and they also provide buy-in to the capitalist institution as a whole.

And yet a growing feeling of mistrust, spanning across the political spectrum from the Tea Party to Occupy Wall Street, seems endemic in our national discourse when discussing both government and the current state of American capitalism. It is tough to determine the underlying roots of this populist anger, but many have pointed to powerful special interests groups, targeted bailouts, "too big to fail" companies, and big business protection at the expense of the consumer as interlinking parts of the same problem.

Inherent in the capitalist system is the risk-reward tradeoff that allows market forces – not special interests and lobbying efforts – to determine the ultimate winners. This tradeoff works well because it allows for an efficient allocation of resources that has brought a higher standard of living to more people than any other economic system. Therefore, Americans are not without good reason to be angered by individual industries and companies receiving special treatment; examples abound, from the creditor bailout of Continental Illinois in 1984 to the structured bailout of AIG and others during the 2008 financial crisis. At the heart of the growing populist anger is the knowledge that private interests continue to profit while the American taxpayer foots the bill for the excessive risk taking within the financial industry.

Most disconcerting is that this new breed of crony capitalism fails to separate the financial industry from the broader economy. While the financial industry provides an important intermediary service to businesses and consumers, its interests do not necessarily coincide with the interests of the broader real economy. By failing to disentangle the zero-sum-benefit financial products from the value-added services, we have allowed bad public policy to encourage myopic risk taking and unethical behavior at the taxpayers' expense.

As more evidence comes to light regarding the LIBOR scandal, we should encourage regulators to bring more evidence into the court system rather than allowing for quick settlements out of court. As The Economist has recently pointed out, out of the 13 settlements within this industry of $5M or more from 2011 through the first half of 2012, all of them have been reached the same day that the SEC filed suit. By allowing for quick settlements out of court, the American public fails to get a full understanding of how these financial manipulations have adversely affected us. The quick settlements further convolute the financial system and allow for insiders to gain leverage based on their privileged insight; this insight provides additional perverse incentives for "regulatory capture" based on the specialized knowledge obtained from the revolving door from industry to government regulator.

The growing populist resentment of the crony capitalism that is taking root in America is not without good reason. Market forces are being distorted based on the concerted efforts of big business and their powerful lobbying groups; their actions reduce competition and protect incumbent firms at the expense of start-ups and less well capitalized companies. As some industries are now dominated by "too big to fail" companies, their internal cultures appear to readily embrace the moral hazard that is buttressed by the faith and credit of the American taxpayer.

Without the traditional civic support for an innovative capitalist system, our dynamic economy will fail to provide the inspiring Horatio Alger stories in which ordinary Americans rise through the ranks to achieve greatness. By protecting certain companies and vested interests, we're also contributing to the hubris within the financial sector, which continues to exploit consumers through information asymmetries, such as in the recent LIBOR scandal.

W. Patrick Lovely, CMA, CPA, is currently an assistant controller at a government contractor and a graduate student in the Applied Economics program at Johns Hopkins University. He serves as a member of IMA's (Institute of Management Accountants) Committee on Ethics.

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