A Fighting Chance or Unsolved Problem

The text message read: "Dude. I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger." It sounded ordinary enough, but the context was much darker.

In as early as 2005, traders around the world in London, New York, and Tokyo began to rig the London interbank offering rate, LIBOR. They asked each other to submit phony numbers to the British Bankers’ Association, who finds LIBOR from the top 16 banks’ submitted median rate. Communicating through calls, emails, and texts, they asked each other to turn in artificial figures in order to derive their desired rate, one that they can readily make money on. Taking advantage of the anachronistic practice, inherited from the 18^th century when only a handful of banks opened shop in London, they exploited its need for a long overdue reform. Furthermore, through blatantly cheating the system, they acted as if they were above the media, the public, and the law, but they were wrong.

In 2012, government regulators such as the SEC, the security and exchange commission, unveiled the rigging and handed out hefty fines to the involved institutions. As part of the settlement, they agreed to disclose their records. As if the traders never bothered to cover their tracks, they left a trail of mind boggling crumbs. The evidences are not only juvenile compared to the sophistication of the financial system, but also insulting to the SEC regulators. One can get the picture just by reading a few lines- LIBOR fixing was rampant and the traders had no filter, no qualms, and no remorse. In some ways, fixing the LIBOR seemed to be as common as rolling up the sleeves and sipping on coffee at work.

Nothing is implied and no decrypting is necessary, they said everything in plain English. One Barclays trader asked another to raise the rate in May 31 2006, “"We have another big fixing tom[orrow] and with the market move I was hoping we could set the 1M and 3M Libors as high as possible." In response, his counterparty followed suit. There is no pledging, no fraternity, and no brotherhood, yet all the traders understood the rule. As financial professionals who studied at similar institutions, received similar trainings, and interested in similar goals, they are all too familiar with the implicit rule of the game, “I scratch your back, and you scratch my back.” As a result, they comply, and often with great enthusiasm. They joked back and forth; traders from all over the world resonated in their light hearted responses, “for you ... anything,” “always happy to help, leave it with me, Sir," and "Done ... for you big boy ...."

Furthermore, while there are some such as RBS’s Tan who saw the fixing justified and filed an unlawful dismissal suit for his firing, most understood the crime. However, the guilty conscience or at least law breaking acknowledgement failed to deter them from participating. As if receiving an honorable invitation to join the mafia, they relished at the opportunity. One trader commented “its just amazing how libor fixing can make you that much money” while the other proclaimed “its a cartel now in london[.]” The unlawful practice was beyond just a few individuals. In 2008, a Barclays Treasury manager claimed that Barclays’ involvement has been overstated, "we're clean, but we're dirty-clean, rather than clean-clean" and the counterparty responded "no one's clean-clean." Such prevalent practice led Barclays to internally agree to defend the banks’ accurate and fair LIBORs to the media on 29 May 2008, as shown in disclosed records.

With the scandal blown out of the water, the media has been at the front and center in covering the rigging. Since 2012, major business publications such as the Wall Street Journal, Financial Times, Business Week, and Economist have dedicated extensive reports on the details of the scandal. Their month long coverage culminated in SEC’s fine announcements. It fined RBS, UBS, and Barclays a combined 2.3 billion dollars and is investigating 20 more firms for their involvement. Given the media’s heavy scrutiny and the law enforcement’s hard response, contrary to the traders’ belief, they were not above the media and the law. However, they may be right about the public.

While the press and the regulatory bodies have all been outraged by this mess, the case has not resonated much with the public. For weeks, finance publications interviewed financial professionals, analyzed the event timeline, and speculated on future regulations. Through eye catching covers and brow raising front pages, they eagerly sought the public’s attention. Yet, as egregious as the rigging is, it does not seem to be much of a surprise to the Main Street- the wolves on Wall Street are still wolves. Long accustomed to the banks’ disappointing behaviors, many may have not only institutionalized their distrust, but also grown numb to the injustices. But that does not convey the full picture.

One potential reason behind Main Street’s underwhelming reaction may be because few understand the depravity of the fixing. In some ways, the traders at the banks were right, what they were doing is above an ordinary person. However, the rigging affects everyone, even to those who intend on hiding behind the veil of inattention and indifference. LIBOR, the London interbank offering rate, is a rate used to set interest rates from all over the world. It affects eight trillion dollar worth of financial derivatives. What this means is that anyone who has a bank account may have been overcharged for the loan or underpaid for the deposits.

LIBOR, which represents the rate at which the top European banks are lending its deposits to each other, is formed organically through supply and demand. Based on the demand for loans by creditors and the supply of deposits from depositors, banks pull back and forth in a tug of war to yield LIBOR. For instance, if creditors have a high demand for loans, banks would prefer to lend to them at the higher rate versus lending to other banks at a lesser rate. At the same time, if creditors have a low demand for loans, banks would prefer to lend to each other at the lower rate versus earning no interest from the idly sitting excess deposits. As a result, given the market forces between banks, LIBOR is formed. Since banks make money from the difference between the rate at which it pays its depositors and the rate at which it charges its creditors, they pay the utmost attention to this process.

LIBOR is then used to set prices for all kinds of financial derivatives. One way to understand it is through a lemonade stand. As if the financial derivatives were the freshly squeezed lemonade, the bank is the lemon farmer. Similar to how the lemon farmer sets the price of the lemon based on the harvest supply and the seasonal demand, the bank sets the cost of borrowing money the same way at LIBOR. As the child buys the lemon, squeezes it into juice, and sells it to kind hearted friends and family, the price of the cup is marked up from the price of the lemons to make up for the labor the child put into running the stand. The cost of borrowing money also increases in the same way. As a result, to the end user, whether it may be a cash starved small business owner, a newly wed house buyer, or freshly loaned student, the interest rates they receive are all the original LIBOR plus some.

While all this information may be too dense for an average reader to understand, hope is not lost. While the Main Street has no idea what is going on, the SEC has been protecting the consumers and have recently stepped up its law enforcement. Signed into law by President Roosevelt in 1933 under the Securities Exchange Act, the SEC investigates frauds, audits financial records, litigates in court, and upholds the law. The agency has been most active in busting insider trading, accounting frauds, and business malpractices. Its notable victories include the WorldCom fraud in 2000s and the Mortgage Backed Securities debacle in 2008. With more than 723 settlements reached in 2012 and an average of 1 million per case, it has fought to return more than 700 million to the victims. Though in the past, it has been criticized for its policy favoring quick settlement over costly and long court room battles, which allows guilty firms to neither admit nor deny and settle with fines, it is undergoing a paradigm shift. It still acknowledges the usefulness of such practice, but is also ready to do whatever it takes to get Wall Street in line.

Since the new commissioner, Mary Jo White, came into power, the SEC has handed out record fines, sought criminal prosecution, and scared the banks into playing nice. Though the SEC is by no means soft, with its 2.3  billion fine to RBS, Barclays, and UBS for LIBOR fixing, 920 million fine to J.P Morgan for its rogue London trader, and 417 million fine to Credit Suisse for mortgage backed securities related issues, it has answered the call to toughen its position. For instance, in addition to having JP Morgan pay 920 million to compensate the shareholders for the damage, it also required the firm to admit to its poor risk management strategies. Forcing the firm to admit to their poor practice, which involved encouraging traders to take riskier bets in a “double or nothing” play in an attempt to recoup the trading loss instead of calling it a day, the SEC is no longer playing the nice cop. It wants the firm to face its mistakes and shareholders straight on. Furthermore, White also reversed the previously agreed settlement with Harbinger Capital Partners to seek harsher punishments for the guilty Philip Falcone. Refusing to let the billionaire walk off easily with paying just a small fraction of his fortune, 18 million out of his 1.2 billion dollars’ net worth to be exact, she overruled the case and opened it up for a new round of settlement.  The overrule decision in August 2013, three months after the initial agreement, is a strong signal that White is serious about reforming the SEC. Lastly, it has recently handed out a record 13 billion dollar fine to JP Morgan for its role in the financial crisis. As the firm that acquired Lehman Brothers and Bear Stearns, two culprit and victim banks of the 2008 financial crisis, JP Morgan is now being held responsible for their acquired firms’ actions. Considering the gravity of these banks’ poor mortgage backed security selling practice, which led to the housing collapse, economic recession, and high employment, the SEC handed out its biggest fine in recorded history. Even after such onerous fine that would wipe away half of JP Morgan’s annual profit, it also kept its right to criminally prosecute the responsible individuals. Five years after the financial crisis, the SEC is cracking down ruthlessly on banks and individuals alike. These decisive moves, all made within White’s short 9 month stint, reflect her determination to clean up Wall Street.

Now with White in power who firmly believes in the SEC’s mission to “protect investors, facilitate capital formation, and insure the fairness and integrity of the marketplace,” the consumers have a fighting chance against the dominant banks. However, it still does not change the fact that traders were right, the fixing was and is above the public. As much as the main street is satisfied with the surged up SEC, the world needs more preventive actions and the preventive actions come from the public. In addition to defrauding and betraying the consumers, LIBOR scandal also demonstrated the scary consequence of people’s inattention. Given the wide knowledge gap between the Wall Street and the main street, financial scandals are likely to happen again and again, all right under people’s nose. Financial illiteracy has contributed to the world’s indifference and apathy to the actions of financial institutions, until something goes wrong. This damaging cycle may be contained by the SEC, but it can only truly be fixed by the public. Through public awareness and civil activism, people can truly make a difference in taming the wolves. The public pressure can deter deregulation lobbyists, accelerate market reforms, and incentivize financial institutions to clean themselves up. As much talk is there about the wrong doings of these banks, there is insufficient concern for the wide spread financial illiteracy. At best, it can lead to minor inconveniences such as paying higher loan rates. At worst, it can lead to financial crimes such as Bernie Madoff’s frauds that lost the investors 18 billion. It is a problem, in which no one ever talks about and given the dominating stakes and influence of the financial industry, people simply cannot afford to ignore it anymore.

For now, the charged up SEC and other regulators have bought the world some time. The SEC continues to investigate banks for their roles. UK’s Financial Security Authority stripped the British Bankers’ Association of its LIBOR calculating responsibility, handed it to a data provider and regulated exchanges, and revamped the rate calculating scheme. UK courts have also begun to try the involved traders criminally and arbitrate on whether to break the financial contracts based on the faulty LIBOR rates. The stepped up regulators are beginning to whip Wall Street in line, however it will not last. Until these white collar criminals learn that they are not above the media, the law, and the public, financial scandals will continue to happen. It may be overly optimistic to wish that society will learn to be financially aware and become agents of change, but it is not too much to ask people for take this problem more seriously until the next one strikes again.