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“We are therefore being dishonest by definition and are at risk of
damaging our reputation in the market and with the regulators.” –
Barclays staff responsible for LIBOR submission, email December 4, 2007.
By now you’ve undoubtedly heard about Barclays’ manipulation
of its submissions to the calculation of the London Interbank Offer
Rates (LIBOR), or rather rates. The Barclays employee quoted above
obviously understood the ramifications of the bank’s actions on the
banks, unfortunately what he missed was something more important, the
extent to which such actions would undermine the public’s support for
both markets and finance, two key ingredients for a wealthy society.
This I fear will be the more long-lasting impact of the LIBOR scandal
and those of us who support free-market should be among the loudest
condemning Barclays’ behavior.
It is not that I believe Barclays (or banks in general) is any more
dishonest than say government politicians and bureaucrats, because in
fact I believe bankers to generally be more honest than your typical
politician (a low standard I know), but because banking is a business
fundamentally built on trust. As we learned so painfully from the
financial crisis, all the credit scores and data in the world does not
guarantee that someone will honor the contract they’ve signed their name
to. One of my greatest concerns is this loss of trust among market
participants that makes any society function. The truth is that rules,
courts and regulations are always going to be costly ways to monitor
society. Trust is one of the great economizers of transactions costs.
When we lose it on a broad scale, society is immensely poorer.
Of course trust alone is often insufficient. Incentives should be
aligned so as to reduce misbehavior. As it relates to LIBOR, my first
suggestion would be to move away from survey based borrowing measures,
like LIBOR, and instead rely on market measures, based upon actual
transactions, which are less subject to manipulation. Perhaps
surprisingly, market measures are likely to be more volatile than
surveys (compare the daily LIBOR and federal funds rates for instance),
but such volatility would be a more honest assessment of market
conditions. In fact one of the ironies, at least to me, is that looking
at the various manipulations presented by the FSA, it isn’t clear,
pre-crisis, that Barclays was even able to move the market with its
false submissions. Of course it isn’t the result here that matters, but
the intent. And if our intent is to have a freer and wealthier
society, then those who abuse our trust should be held to account.
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