Banking and Wall Street: The Economist on “Then and Now” http://bit.ly/LJosNz Last week, the British press was in full-throated cry on the Libor scandal , both as a political story (the connections to the Conservative party; the questions over the Bank of England’s role) and for its economic repercussions (who else was involved, who wound up on the losing side). Many commentators took note of the Economist’s cover: But despite the dramatic image and the use of the pejorative “banksters,” the articl e combined some helpful analysis with a call not to act against banks in haste: The attempts to rig LIBOR (the London inter-bank offered rate), a benchmark interest rate, not only betray a culture of casual dishonesty; they set the stage for lawsuits and more regulation right the way round the globe. This could well be global finance’s “tobacco moment”. The dangers of this are obvious. Popular fury and class- action suits are seldom a good starting point for new rules. Yet despite the risks of banker-bashing, a clean-up is in order, for the banking industry’s credibility is shot, and without trust neither the business nor the clients it serves can prosper…. Translation: don’t do too much while tempers are hot. Yet this stance also happens to be the one used again and again by incumbents and lobbyists: drag out discussions of what to do until the public’s attention has moved elsewhere. As Frank Partnoy recounted in his book Infectious Greed, this strategy was particularly effective in the 1994 derivatives wipeout, which destroyed more wealth than the 1987 crash. A series of investigations and hearings in the end produced close to nothing because the banking industry was able to drag out the process, and then argue that things were back to normal, so why were any changes needed? The Economist’s recommendations: The first is to find out exactly what happened and to punish those involved. Where the only motive was greed, the individuals directly involved in fraud should face jail. If the rate was lowered to keep the bank afloat, and regulators were involved, both the bankers and their rule-setters should explain why they took it upon themselves to endanger the City’s reputation in this way… The second task is to change the way finance is run—and the culture of banking. This after all is not the first price-fixing scandal: Wall Street has had several. A witch hunt would be disastrous (see Bagehot), but culture flows from structure. The case for splitting retail and investment banks on “moral” grounds is weak, but individual banks could do more: drawing fines from the bonus pool is one example. And some rules must change. LIBOR is set under the aegis not of the regulator but of a trade body, the British Bankers’ Association. That may have worked in the gentlemanly days when “the governor’s eyebrows” were enough to keep bankers in order. These days the City is the world’s biggest centre of international finance. This is thin gruel, particularly for a scandal of this magnitude. What seems to have contributed to the outrage in the UK is the casualness and regularity with which Barclays diddled with Libor. It correctly points to the way it has become normal for bankers to cheat every way possible to pad their wallets. Bid rigging and collusion are appallingly widespread. We haven’t even gone looking for it on the blog, yet have come across it frequently. For instance, in the early phases of the crisis, in the CLO and RMBS markets, it was widely known that dealers would “trade” very small order sizes with friendly parties (back scratching with other banks or with hedge funds) to establish phony (as in inflated) prices for valuation purposes. Similarly, it was common for CDO desks to cooperate with preferred short sellers and give them a “last look” at bids on credit default swaps, meaning allowing them a look at their orders in what was presented to most customers as an auction where all participants were treated equally. There is also…

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